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National Institute of Business Management

Chennai - 020

FIRST SEMESTER EMBA/ MBA

Subject : Financial Management

Attend any 4 questions. Each question carries 25 marks

(Each answer should be of minimum 2 pages / of 300 words)

1. Explain the objectives of financial management, interphase between finance and

other functions.

2. Explain the Indian Financial Systems.

3. Explain debentures as instruments for raising long-term debt capital.

4. What are Inventories? Explain.

5. Explain the different sources of cash.

6. What is cash budget and proforma balance sheet? Explain.

25 x 4=100 marks
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ANSWERS
1. Explain the objectives of financial management, interface between finance and other
functions.

Objectives of financial management

According to Ezra Soloman & John. J.Pringle, “Financial Management is concerned with the
efficient use of an important economic resource, namely, Capital Funds. Traditionally the basic
objectives of financial management are the
 Maintenance of liquid assets.
 Maximization of profitability of the firm.
Maintenance of liquid assets is to ensure that the firm has adequate cash in hand to meet its
obligations at all times.
Profit Maximization: Suppose the Finance Manager manages to make available the required
funds at an acceptable cost and that the funds are suitably invested and that everything goes
according to plan because of the effective control measures used. A business firm is a profit-
seeking organisation. Hence, profit maximization is also well considered to be an important
objective of financial management. The results of good performance are reflected as profits of
the firm.
Maximization of wealth: Profit maximization is not considered to be an ideal criterion for
making investment and financing decisions. Prof. Ezra Soloman has suggested the adoption of
wealth maximization as the best criterion for the financial decision-making. The objective of a
firm or company must be to create value for its shareholders. Value is represented by the market
price of the company’s common stock, which, in turn is a function of the firm’s investment,
financing and dividend decisions. The idea is to acquire assets and invest in new products and
services where expected return exceeds their cost, to finance with those instruments where there
is particular advantage, tax or otherwise, and to undertake a meaningful dividend policy for
stockholders.
Thus, wealth maximization or value creation is considered to be the main objective of
modern financial management.
 It is possible to have non-financial corporate objectives which may or may not conflict with
the financial objective of shareholder wealth maximization. Some of the non-financial
corporate objectives are:
 Total employment generation
 Employee welfare
 Rate of growth of business
 Increase in market share.
 Technological leadership through substantial investment in research and development.
 Customer satisfaction.
 Community welfare.

Interface between finance and other functions: The finance manager depends upon the inputs
provided by other operating managers:
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 The production manager or engineer, who is accountable for optimum use of equipment
and facilities and of the funds invested therein;
 The marketing manager, answerable for the forecast of demand for the product, customer
satisfaction, credit policy etc;
 The top management, which is interested in ensuring that the firm’s long-term goals are
met.

Finance is the study of money management, the acquiring of funds (cash) and the directing of
these funds to meet particular objectives. Good financial management helps businesses to
maximize returns while simultaneously minimizing risks.
Financial management is an integral part of overall management and not merely a staff
function. It is not only confined to fund raising operations but extends beyond it to cover
utilization of funds and monitoring its uses. These functions influence the operations of other
crucial functional areas of the firm such as production, marketing and human resources. Hence,
decisions in regard to financial matters must be taken after giving thoughtful consideration to
interests of various business activities. Finance manager has to see things as a part of a whole
and make financial decisions within the framework of overall corporate objectives and policies.
Let us discuss in greater detail the reasons why knowledge of the financial implications of
their decisions is important for the non-finance managers. One common factor among all
managers is that they use resources and since resources are obtained in exchange for money, they
are in effect making the investment decision and in the process of ensuring that the investment is
effectively utilized they are also performing the control function.

Marketing-Finance Interface
There are many decisions, which the Marketing Manager takes which have a significant location,
etc. In all these matters assessment of financial implications is inescapable impact on the
profitability of the firm. For example, he should have a clear understanding of the impact the
credit extended to the customers is going to have on the profits of the company. Otherwise in his
eagerness to meet the sales targets he is liable to extend liberal terms of credit, which is likely to
put the profit plans out of gear. Similarly, he should weigh the benefits of keeping a large
inventory of finished goods in anticipation of sales against the costs of maintaining that
inventory.

Production-Finance Interface:
As we all know in any manufacturing firm, the Production Manager controls a major part
of the investment in the form of equipment, materials and men. He should so organize his
department that the equipments under his control are used most productively, the inventory of
work-in-process or unfinished goods and stores and spares is optimized and the idle time and
work stoppages are minimized. If the production manager can achieve this, he would be holding
the cost of the output under control and thereby help in maximizing profits. He has to appreciate
the fact that whereas the price at which the output can be sold is largely determined by factors
external to the firm like competition, government regulations, etc. the cost of production is more
amenable to his control. Similarly, he would have to make decisions regarding make or buy, buy
or lease etc. for which he has to evaluate the financial implications before arriving at a decision.

Top Management-Finance Interface:

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The top management, which is interested in ensuring that the firm’s long-term goals are
met, finds it convenient to use the financial statements as a means for keeping itself informed of
the overall effectiveness of the organization. We have so far briefly reviewed the interface of
finance with the non-finance functional disciplines like production, marketing etc. Besides these,
the finance function also has a strong linkage with the functions of the top management.
Strategic planning and management control are two important functions of the top management.
Finance function provides the basic inputs needed for undertaking these activities.

Economics – Finance Interface:

The field of finance is closely related to economics. Financial managers must understand
the economic framework and be alert to the consequences of varying levels of economic activity
and changes in economic policy. They must also be able to use economic theories as guidelines
for efficient business operation. The primary economic principle used in managerial finance is
marginal analysis, the principle that financial decisions should be made and actions taken only
when the added benefits exceed the added costs. Nearly all-financial decisions ultimately come
down to an assessment of their marginal benefits and marginal costs.

Accounting – Finance Interface:

The firm’s finance (treasurer) and accounting (controller) activities are typically within
the control of the financial vice president (CFO). These functions are closely related and
generally overlap; indeed, managerial finance and accounting are often not easily
distinguishable. In small firms the controller often carries out the finance function, and in large
firms many accountants are closely involved in various finance activities. However, there are two
basic differences between finance and accounting; one relates to the emphasis on cash flows and
the other to decision making.
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2. Explain the Indian Financial Systems.

Economic growth and development of any country depends upon a well-knit financial
system. Financial system comprises a set of sub-systems of financial institutions financial
markets, financial instruments and services which help in the formation of capital. Thus a
financial system provides a mechanism by which savings are transformed into investments and it
can be said that financial system play an significant role in economic growth of the country by
mobilizing surplus funds and utilizing them effectively for productive purpose.
The financial system is characterized by the presence of integrated, organized and regulated
financial markets, and institutions that meet the short term and long term financial needs of both
the household and corporate sector. Both financial markets and financial institutions play an
important role in the financial system by rendering various financial services to the community.
They operate in close combination with each other.

Financial System;

The word "system", in the term "financial system", implies a set of complex and closely
connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities
in the economy. The financial system is concerned about money, credit and finance-the three
terms are intimately related yet are somewhat different from each other. Indian financial system
consists of financial market, financial instruments and financial intermediation.
Role/ Functions of Financial System: A financial system performs the following
functions:

 It serves as a link between savers and investors. It helps in utilizing the mobilized savings of
scattered savers in more efficient and effective manner. It channelizes flow of saving into
productive investment.
 It assists in the selection of the projects to be financed and also reviews the performance of
such projects periodically.
 It provides payment mechanism for exchange of goods and services.
 It provides a mechanism for the transfer of resources across geographic boundaries.
 It provides a mechanism for managing and controlling the risk involved in mobilizing
savings and allocating credit.
 It promotes the process of capital formation by bringing together the supply of saving and the
demand for investible funds.
 It helps in lowering the cost of transaction and increase returns. Reduce cost motives people
to save more.
 It provides you detailed information to the operators/ players in the market such as
individuals, business houses, Governments etc.
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Components/ Constituents of Indian Financial system: The following are the four main
components of Indian Financial system.
 Financial institutions
 Financial Markets
 Financial Instruments/Assets/Securities
 Financial Services

Financial institutions:
Financial institutions are the intermediaries who facilitate smooth functioning of the
financial system by making investors and borrowers meet. They mobilize savings of the surplus
units and allocate them in productive activities promising a better rate of return. Financial
institutions also provide services to entities seeking advise on various issues ranging from
restructuring to diversification plans. They provide whole range of services to the entities who
want to raise funds from the markets elsewhere. Financial institutions act as financial
intermediaries because they act as middlemen between savers and borrowers. Were these
financial institutions may be of Banking or Non-Banking institutions.

Financial Markets:
Finance is a prerequisite for modern business and financial institutions play a vital role in
economic system. It's through financial markets the financial system of an economy works. The
main functions of financial markets are:
 to facilitate creation and allocation of credit and liquidity;
 to serve as intermediaries for mobilization of savings;
 to assist process of balanced economic growth;
 to provide financial convenience

Financial Instruments
Another important constituent of financial system is financial instruments. They represent
a claim against the future income and wealth of others. It will be a claim against a person or
institutions, for the payment of the some of the money at a specified future date.

Financial Services:
Efficiency of emerging financial system largely depends upon the quality and
variety of financial services provided by financial intermediaries. The term financial
services can be defined as "activities, benefits and satisfaction connected with sale of
money, that offers to users and customers, financial related value".
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Pre-reforms Phase
Until the early 1990s, the role of the financial system in India was primarily restricted to
the function of channeling resources from the surplus to deficit sectors. Whereas the financial
system performed this role reasonably well, its operations came to be marked by some serious
deficiencies over the years. The banking sector suffered from lack of competition, low capital
base, low Productivity and high intermediation cost. After the nationalization of large banks in
1969 and 1980, the Government-owned banks dominated the banking sector. The role of
technology was minimal and the quality of service was not given adequate importance. Banks
also did not follow proper risk management systems and the prudential standards were weak. All
these resulted in poor asset quality and low profitability. Among non-banking financial
intermediaries, development finance institutions (DFIs) operated in an over-protected
environment with most of the funding coming from assured sources at concessional terms. In the
insurance sector, there was little competition. The mutual fund industry also suffered from lack
of competition and was dominated for long by one institution, viz., the Unit Trust of India. Non-
banking financial companies (NBFCs) grew rapidly, but there was no regulation of their asset
side. Financial markets were characterized by control over pricing of financial assets, barriers to
entry, high transaction costs and restrictions on movement of funds/participants between the
market segments. This apart from inhibiting the development of the markets also affected their
efficiency.

Financial Sector Reforms in India

It was in this backdrop that wide-ranging financial sector reforms in India were
introduced as an integral part of the economic reforms initiated in the early 1990s with a view to
improving the macroeconomic performance of the economy. The reforms in the financial sector
focused on creating efficient and stable financial institutions and markets. The approach to
financial sector reforms in India was one of gradual and non-disruptive progress through a
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consultative process. The Reserve Bank has been consistently working towards setting an
enabling regulatory framework with prompt and effective supervision, development of
technological and institutional infrastructure, as well as changing the interface with the market
participants through a consultative process. Persistent efforts have been made towards adoption
of international benchmarks as appropriate to Indian conditions. While certain changes in the
legal infrastructure are yet to be effected, the developments so far have brought the Indian
financial system closer to global standards.
The reform of the interest regime constitutes an integral part of the financial sector
reform. With the onset of financial sector reforms, the interest rate regime has been largely
deregulated with a view towards better price discovery and efficient resource allocation. Initially,
steps were taken to develop the domestic money market and freeing of the money market rates.
The interest rates offered on Government securities were progressively raised so that the
Government borrowing could be carried out at market-related rates. In respect of banks, a major
effort was undertaken to simplify the administered structure of interest rates. Banks now have
sufficient flexibility to decide their deposit and lending rate structures and manage their assets
and liabilities accordingly. At present, apart from savings account and NRE deposit on the
deposit side and export credit and small loans on the lending side, all other interest rates are
deregulated. Indian banking system operated for a long time with high reserve requirements both
in the form of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). This was a
consequence of the high fiscal deficit and a high degree of monetization of fiscal deficit. The
efforts in the recent period have been to lower both the CRR and SLR. The statutory minimum of
25 per cent for SLR has already been reached, and while the Reserve Bank continues to pursue
its medium-term objective of reducing the CRR to the statutory minimum level of 3.0 per cent,
the CRR of SCBs is currently placed at 5.0 per cent of NDTL.
As part of the reforms programme, due attention has been given to diversification of
ownership leading to greater market accountability and improved efficiency. Initially, there was
infusion of capital by the Government in public sector banks, which was followed by expanding
the capital base with equity participation by the private investors. This was followed by a
reduction in the Government shareholding in public sector banks to 51 per cent. Consequently,
the share of the public sector banks in the aggregate assets of the banking sector has come down
from 90 per cent in 1991 to around 75 per cent in2004. With a view to enhancing efficiency and
productivity through competition, guidelines were laid down for establishment of new banks in
the private sector and the foreign banks have been allowed more liberal entry. Since 1993, twelve
new private sector banks have been set up. As a major step towards enhancing competition in the
banking sector, foreign direct investment in the private sector banks is now allowed up to 74 per
cent, subject to conformity with the guidelines issued from time to time.
Conclusion: The Indian financial system has undergone structural transformation over
the past decade. The financial sector has acquired strength, efficiency and stability by the
combined effect of competition, regulatory measures, and policy environment. While
competition, consolidation and convergence have been recognized as the key drivers of the
banking sector in the coming years.
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3. Explain debentures as instruments for raising long-term debt capital.

Debt Capital
Debt capital is funds supplied by lender that is part of a company’s capital structure. Debt
capital usually refers to long-term capital, specifically bonds, rather than short-term loans to be
paid off within one year.
Debt capital differs from equity or share capital because subscribers to debt capital do not
become part owners of the business, but are merely creditors, and the suppliers of debt capital
usually receive a contractually fixed annual percentage return on their loan, and this is known as
the coupon rate. Debt refers to capital that is loaned by a lender to a borrower, who is in turn
obligated (1) to repay the original amount loaned–or the principal–within a specified time period,
and (2) to pay interest on the principal.
Debt capital ranks higher than equity capital for the repayment of annual returns. This
means that legally, the interest on debt capital must be repaid in full before any dividends are
paid to any suppliers of equity.
The main source of debt capital for Indian corporate expansion has traditionally been the
strong domestic bank loan market. The existence of a vibrant debt capital market is important
from a macro-economic perspective to provide mechanisms for greater sources of financing and
liquidity and for risk minimization in any economy. In India, while equity capital markets have
developed significantly in terms of liquidity, infrastructure and regulatory framework, the debt
capital markets have traditionally lagged behind.
The various instruments of debt can be classified into long term, medium term and short
term debt depending on the tenure for which the amount has been raised or the period of
repayment. Apart from term loan and credit facilities, the various instruments of debt are
mentioned below.
 Bonds
 Debenture
 Equipment Financing
 Deposit (including Public Deposit)
 Commercial Paper
 Inter-corporate Debt
Mezzanine Debt is a different type of debt that typically has both debt and equity
characteristics. Mezzanine Debt carries a higher interest rate and some form of equity options (an
equity interest in the company‐ typically in the form of stock or warrants) to drive acceptable
risk‐adjusted returns. Here we would be discussing the legal framework for issue of Debenture
specifically and debt instrument in general.

Debenture
The Companies Act, 1956 (“Companies Act”) defines ‘debenture’ as “debenture”
includes debenture stock, bonds and any other securities of a company, whether constituting a
charge on the assets of the company or not;
In modern commercial usage, a debenture denotes an instrument issued by the company,
normally but not necessarily, called on the face of it a debenture, and providing for the payment
of, or acknowledging the indebtedness in a specified sum, at a fixed rate, with interest thereon. It
usually, but not necessarily, gives a charge by way of security, and is often, though not
invariably, expressed to be one of a series of like debentures. But the term as used in the modern
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commercial parlance is of extremely elastic character. Following are the basic characteristics of
debentures.
 It is a document containing an acknowledgement of indebtedness.
 Debentures are issued in form of certificates.
 Debenture may be secured or unsecured. Debentures need not necessarily create a charge
on the company’s assets. Section 2(12) provides that debenture may or may not constitute
a charge on the assets of the company.
 Debentures are generally issued under the common seal of the company.
 Debenture holders do not have any right to vote at any meeting of the company. In terms
of provisions of section 117 of the Act, no company shall, after the commencement of
this Act, issue any debentures carrying voting rights at any meeting of the company,
whether generally or in respect of particular classes of business.
 Debentures may be convertible or non-convertible.
 Debentures may or may not be one of a series.
 (viii) Debentures carry interest at a fixed rate.

Classification of Debenture

Debentures are classified into various types. These are redeemable, irredeemable,
perpetual, convertible, non convertible, fully, partly, secured, mortgage, unsecured, naked, first
mortgaged, second mortgaged, bearer, fixed, floating rate, coupon rate, zero coupon, secured
premium notes, callable, potable, etc.
Debentures are classified into different types based on their tenure, redemption, mode of
redemption, convertibility, security, transferability, type of interest rate, coupon rate, etc.
Following are the various types of debentures vis-a-vis their basis of classification
 Redemption / Tenure: Redeemable and Irredeemable (Perpetual) Debentures:
Redeemable debentures carry a specific date of redemption on the certificate. The
company is legally bound to repay the principal amount to the debenture holders on that
date. On the other hand, irredeemable debentures, also known as perpetual debentures, do
not carry any date of redemption. This means that there is no specific time of redemption
of these debentures. They are redeemed either on the liquidation of the company or when
the company chooses to pay them off to reduce their liability by issues a due notice to the
debenture holders beforehand.
 Convertibility: Convertible and Non Convertible Debentures: Convertible debenture
holders have an option of converting their holdings into equity shares. The rate of
conversion and the period after which the conversion will take effect are declared in the
terms and conditions of the agreement of debentures at the time of issue. On the contrary,
non convertible debentures are simple debentures with no such option of getting
converted into equity. Their state will always remain of a debt and will not become equity
at any point of time.
 Fully and Partly Convertible Debentures: Convertible Debentures are further
classified into two – Fully and Partly Convertible. Fully convertible debentures are
completely converted into equity whereas the partly convertible debentures have two
parts. Convertible part is converted into equity as per agreed rate of exchange based on
agreement. Non convertible part becomes as good as redeemable debenture which is
repaid after the expiry of the agreed period.
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 Security: Secured (Mortgage) and Unsecured (Naked) Debentures: Debentures are

secured in two ways. One when the debenture is secured by charge on some asset or set
of assets which is known as secured or mortgage debenture and another when it is issued
solely on the credibility of the issuer is known as naked or unsecured debenture. A trustee
is appointed for holding the secured asset which is quite obvious as the title cannot be
assigned to each and every debenture holder.
 First Mortgaged and Second Mortgaged Debentures: Secured / Mortgaged debentures
are further classified into two types – first and second mortgaged debentures. There is no
restriction on issuing different types of debentures provided there is clarity on claims of
those debenture holders on the profits and assets of the company at the time of
liquidation. First mortgaged debentures have the first charge over the assets of the
company whereas the second mortgage has the secondary charge which means the
realization from the assets will first fulfill obligation of first mortgage debentures and
then will do for second ones.
 Transferability / Registration: Registered Unregistered Debentures (Bearer) Debenture:
In the case of registered debentures, the name, address, and other holding details are
registered with the issuing company and whenever such debenture is transferred by the
holder; it has to be informed to the issuing company for updating in its records.
Otherwise the interest and principal will go the previous holder because company will
pay to the one who is registered. Whereas, the unregistered commonly known as bearer
debenture. can be transferred by mere delivery to the new holder. They are considered as
good as currency notes due to their easy transferability. The interest and principal is paid
to the person who produces the coupons, which are attached to the debenture certificate
and the certificate respectively.
 Type of Interest Rates” Fixed and Floating Rate Debentures: Fixed rate debentures have
fixed interest rate over the life of the debentures. Contrarily, the floating rate debentures
have floating rate of interest which is dependent on some benchmark rate say LIBOR etc.
 No Coupon Rate: Zero Coupon and Specific Rate Debentures: Zero coupon debentures
do not carry any coupon rate or we can say that there is zero coupon rate. The debenture
holder will not get any interest on these types of debentures. Need not to get surprised,
for compensating against no interest, companies issue them at a discounted price which is
very less compared to the face value of it. The implicit interest or benefit is the difference
between the issue price and the face value of that debenture. These are also known as
‘Deep Discount Bonds’ .All other debentures with specified rate of interest are specific
rate debentures which are just like a normal debenture.
 Secured Premium Notes / Debentures: These are secured debentures which are
redeemed at a premium over the face value of the debentures. They are similar to zero
coupon bonds. The only difference is that the discount and premium. Zero coupon bonds
are issued at discount and redeemed at par whereas the secured premium notes are issued
at par and redeemed at premium.
 Mode of Redemption: Callable and Puttable Debentures / Bonds: Callable debentures
have an option for the company to buyback and repay to the investors whereas in case of
puttable debentures, the option lies with the investors. Puttable debenture holders can ask
the company to redeem their debenture and ask for principal repayment.

Legal Framework regulating Debentures in India

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Primarily, debentures in India are regulated by Government of India (“Central Govt.”),

Securities Exchange Board of India (“SEBI”) and Reserve Bank of India (“RBI”) under various
legislation like, the Companies Act, Securities Exchange Board of India Act, 1992 (“SEBI Act”),
Securities Contract Regulation Act, 1956 (“SCRA”), Reserve Bank of India Act, 1934 (“RBI
Act”), Foreign Exchange Management Act, 1999 (“FEMA”) etc. along with regulations and
notifications prescribed there under. The nature of debentures issued, type of issuing company,
residential status of debenture subscribing persons etc. are the factors to determine which
regulations are applicable on such debentures.
The Company investing in the debentures has to comply with Section 372A of the
Companies Act. Any amount raised by the issue of debentures secured by the mortgage of any
immovable property of the company or with an option to convert them into shares in the
company provided that in case of such debentures secured by the mortgage of any immovable
property the amount of such debentures shall not exceed the market value of such immovable
property. The exemption is not given if any debenture is not adequately secured by the mortgage
of any immovable property.
It has been clarified that in case of debenture which are partly convertible into shares,
only the convertible portion of the debentures is exempted in terms of the above exemption.
Even in regard to the convertible portion of debentures, once the period of conversion is over, the
unconverted portion of debentures would acquire the character of loan and would fall within the
definition of “Deposit”, provided they are not adequately secured by mortgage or immovable
property of the company.
Unsecured debenture with an option to convert a part of them into shares of the company
concerned are not covered in rule 2(b)(x) of the Acceptance of Deposit Rules. Further only so
long as option to convert unsecured debentures into shares remains in force such unsecured
debentures shall not be subject to discipline of Section 58-A of the Companies Act and rules
made there under. Any amount received from a person who, at the time of the receipt of the
amount, was a director of the company or any amount received from a relative of a director or its
member by a private company: Provided that the director, relative of a director or member, as the
case may be, from whom money is received, furnishes to the company at the time of giving the
money, a declaration in writing to the effect that the amount is not being given out of funds
acquired by him by borrowing or accepting from others This rule exempt any amount received
by all companies (private as well as public) from the definition of “Deposit”, if such amount is
received from its directors (i.e. not joint deposit with non-directors). However as regards to
amount received from a shareholder (i.e. not joint deposit with non-shareholder) or relative of
directors, this rule exempt only private companies from the definition of “Deposit”. For any
invitation and acceptance of unsecured loans/deposits from relatives of directors and members,
the public company will have to comply with the Acceptance of Deposit Rules.
Private company is prohibited from inviting or accepting any debentures from public.
However a private company can accept debentures through private arrangement from its
members, directors and directors’ relatives.
The money received from a director continues to be treated as exempted deposit when the
person from whom money has been received ceases to be a director of the company. But, the
case is not same in case of a shareholder. If a shareholder from whom company has received any
money ceases to be a member of the company, the exemption ceases and, thus, the amount
received from him will be considered as “Deposit” within the meaning of section 58A.
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If a private limited company accept an amount, which may be classified as deposit under
section 58A read with the Companies (Acceptance of Deposits) Rules, 1975, it will cease its
status of a private limited company and has to make all the compliances for such deposits as per
requirement of the said rules, as well as to comply with all the provisions as may be applicable
on public limited company such as sections 58A, 58AA, 58AAA, 81, 256, 257, 198, 268, 269,
Schedule XIII, 274(i)(g) 295, 297, 300, 301, 372A, etc.

Procedure for issue of Debentures

The term ‘prospectus’ means any document described or issued as a prospectus and
includes any notice, circular, advertisement or other document inviting offers from the public or
inviting offers from the public for the subscription or purchase of any shares in, or debentures
securities of a body corporate.
Any offer of shares or securities / debentures to the general public must be made by
issuance of the prospectus. SEBI (Issue of Capital and Disclosure Requirements) Regulations,
2009 (“ICDR Regulations”) for issue of fresh share capital issued by SEBI have to be followed.
Even if shares or securities / debentures are offered by the public unlisted companies to
certain selected persons, the statement in lieu of prospectus has to be issued. Section 58-B of the
Companies Act provides that the provision of the Companies Act relating to the prospectus shall,
so far as may be, apply to an advertisement referred to in Section 58-A. Only a public company
has power and privilege to issue prospectus to public for subscription of shares in or debentures
of the company. The prospectus of a public company shall contain matters specified in Part I of
Schedule II of the Companies Act and shall set out the reports specify in Part II of Schedule II to
the Companies Act.[26] If a public company does not issue a prospectus with reference to its
formation then it has to file a statement in lieu of prospectus with the concerned Registrar of
Companies. A private company cannot invite public to subscribe for its shares in or debentures,
therefore, it cannot issue prospectus.

Transfer of Debentures
The debentures in a company are movable property, transferable in the manner provided
by the articles of the Company. The definition of “goods” in the Sale of Goods Act, 1930,
specifically includes stocks and shares, Hence it is necessary to provide by the articles the
manner in which transfers are to be affected. In absence of specific provisions for transfer of
Debentures, the regulations in Table A of Schedule I of the Companies Act will apply. Where the
articles do not provide for the transfer of shares or debentures, and also expressly exclude the
application of the regulations in Table A of Schedule I of the Companies Act to the company, the
general law relating to transfer of movable property will govern. But though for purposes of
transfer, a share or debenture is to be treated as movable property, it is not, in fact, just so much a
chattel as a garment or a piece of furniture. It is bound inextricably with the company of whose
share capital it is a share and carries certain rights and obligations inseparable from the company
A company cannot refuse to accept transfer of shares or debentures except as provided by
its articles. It is well settled that unless the articles otherwise provide, a shareholder or debenture
holder has a free right to transfer his shares to whom he chooses. It is not necessary to look to the
articles of association of the Company for power to transfer, since that power is given by the
Companies Act. It is only necessary to look to the articles of association of the company to
ascertain the mode of transfer and the restriction upon it. Thus, a clause in the articles of
association of the company providing an absolute restriction on transfer is void.
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Advantages of Long-Term Debt Financing

From the issuing firm's perspective, the major advantages of long-term debt financing are
as follows:

 Debt is least costly source of long-term financing.

 Debt financing provides sufficient flexibility in the financial/capital structure of the
company. Flexibility in capital structure of the company can be increased by inserting call
provision in the bond indenture. In case of over capitalization, the company can redeem
the debt to balance its capitalization.
 Bond holders are creditors and have no interference in business operations because they
are not entitled to vote.
 The company can enjoy tax saving on interest on debt.

Disadvantages of Long-Term Debt Financing: Long-term debt financing has some

disadvantages from firm's viewpoint as follows:

 Interest on debt is permanent burden to the company. Company has to pay the interest to
bondholders or creditors at fixed rate whether it earns profit or not. It is legally liable to
pay interest on debt.
 Debt usually has a fixed maturity date. Therefore, the financial officer must make
provision for repayment of debt.
 Debt is the most risky source of long-term financing. Company must pay interest and
principal at specified time. Non-payment of interest and principal on time take the
company into bankruptcy.
 Debenture indentures may contain restrictive covenants which may limit the company's
operating flexibility in future.
 Only large scale, creditworthy firm, whose assets are good for collateral can raise capital
from long-term debt.

From the investor's point of view, in general, debt securities offer stable returns. Further, if
the company is liquidated then debenture holders are paid before preferred stockholders and
common stockholders. Bondholders are creditors; However, they do not participate in any
increased earnings the firm may experience. Similarly, they do not get right to vote.
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4. What are Inventories? Explain.

Inventory is an important and valuable asset. Inventories, like receivables, represent a very
large portion of a firm’s current assets. Inventory covers a wide variety of items, which are meant
to be procured, used up and sold in the ordinary course of business. The items forming
inventories can be grouped into three categories:
 Raw materials
 Work-in-process
 Finished goods.
Raw material inventory represents the items of basic input for processing.
Work-in-process covers all items, which are at various stages of production process. This is
an intermediary item between raw materials and finished goods. i.e., these items have ceased to
be raw material but have not developed into final products and are at various stages of semi-
finished levels.
Finished goods are completed products awaiting sale. They are final output of the production
process in a manufacturing firm.
The levels of raw materials, work-in-process and finished goods differ depending upon the
nature of the business. Inventories form a link between production and sale of a product. The
money blocked in inventories is substantial, and monitoring the movement of this asset requires
considerable attention from the finance manager. Good inventory management is good finance
management. A company should maintain adequate stock of materials of right quality at
minimum cost so that they are issued to production when needed in order to have uninterrupted
flow of production. Inadequate inventories will disturb the production line and result in loss of
sales.

Benefits of Holding Inventories

The specific benefits of holding inventories are:

 Avoiding losses of sales: Without required goods on hand, which are ready to be sold,
most firms would lose business. i.e., if the firm maintains adequate inventories, it can
avoid losses on account of losing the customers for non-supply of goods in time. Shelf
stock is items that are stored by the business and sold to the customers, with little or no
modification, such as automobile. Customers may specify minor variations, but the basic
item from the factory now available on stock is sold as a standard item.
 Quantity discounts: Suppliers offer reduction in price for making bulk purchases to their
customers. Maintenance of large inventories in selected product lines enables the firm to
make bulk purchase of goods at large discounts.
 Reducing Ordering cost: Each time a firm places an order, it incurs certain expenses. The
variable costs associated with individual orders, such as typing, checking, approving and
mailing the order etc., can be reduced if a firm places a few large orders rather than
numerous small orders.
 Achieving efficient production runs : Each time a firm sets up workers and machines to
produce an item, start up costs are incurred. Maintenance of large inventories helps a firm
in reducing the set up costs associated with each production run. For example, if the set
up cost is Rs.20,000 and the run produces 2000 units, the cost per unit comes to Rs.10. If
the number of units produced is 20000 then the set up cost per unit comes down to Re.1
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per unit. Frequent setups produce high set up costs, and longer runs (i.e., producing more
no. of units) involve lower costs.
 Reducing risk of production shortages : If any critical component for the production is
not available when required, the entire production operation will be halted, with
consequential heavy losses.

Risks of Holding Inventories

The following are the risks associated with holding inventories:
a. Reduction/decline in market price. This is dependent upon the market supply of the
product, introduction of a new competitive product and price-cutting by the competitors
etc.
b. Deterioration of product. Product deterioration may be caused due to holding a product
for too long a period or improper storage conditions.
c. Obsolescence of product. The changes in customers’ tastes, introduction of new
production techniques, improvements in the product design, specifications etc., may lead
to obsolescence of the product.

Cost of Holding Inventories: The costs associated with holding of inventories can be broadly
classified into two.
Direct costs and indirect costs: The direct costs of holding inventories are as follows:
 Materials cost: These are the costs of purchasing the goods including transportation and
handling charges less any discount allowed by the supplier of goods.
 Ordering cost: It refers to the variable costs associated with placing an order for the
goods. The fewer the orders, the lower will be the total ordering cost for the firm. The
ordering cost per order remains more or less constant irrespective of the size of the order
although transportation and inspection costs may vary to a certain extent depending upon
order size. i.e., ordering costs are invariant to the order size. The total ordering costs can
be reduced by increasing the size of the orders.
 Carrying cost: This refers to the expenses for storing the goods. It comprises storage
costs, insurance costs, rent and depreciation of warehouse, salaries of storekeeper,
security personnel, spoilage costs, taxes, cost of funds tied up in inventories etc. Carrying
costs are taken as a percentage of the value of inventory held in the warehouse, despite
some of the fixed elements of costs, which comprise only a small portion of total carrying
costs.

Objectives of Inventory Management: The main objectives of inventory management are:

 to ensure that the materials are available for use in production as and when required,
facilitating uninterrupted production,
 to maintain sufficient stock of raw materials in periods of short supply,
 to ensure that inventory of finished goods is adequate to fulfil the customers’ orders as
per committed delivery schedules,
 to optimize the investment in inventories and
 to protect the inventory from deterioration and obsolescence by providing for proper
warehousing and insurance.

Inventory Management Techniques

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We have already seen that while the total ordering costs can be decreased by increasing
the size of order, the carrying costs increase with the increase in order size, indicating the need
for a proper balancing of these two types of costs behaving in opposite directions with changes in
size of the order. Effective inventory management requires an effective control over inventories.
Inventory control refers to a system, which ensures supply of required quantity and quality of
inventories at the required time and at the same time prevents unnecessary investment in
inventories. The following are the various techniques of inventory control:

 Determination of Economic Ordering Quantity (EOQ)

Determination of EOQ means determination of the right quantity to be purchased.
It is important to note that only the correct quantity of materials is to be purchased. There
should not be any over stock or stock-out. A balance is to be maintained between the cost
of carrying and no carrying costs (i.e., cost of stock-out). EOQ is the quantity fixed at the
point where the total cost of ordering and the cost of carrying the inventory would be the
minimum. If the quantity of purchases is increased, the cost of ordering decreases while
the cost of carrying increases. If the quantity of purchase is decreased the cost of ordering
increases whiles the cost of carrying decreases. The total of both the costs should be kept
at minimum.
 Determination of Re-order level
This is with regard to the timing of purchase. i.e., as to when to purchase. Re-
order level is that level of inventory at which the firm should place an order to replenish
the inventory. In case, the order is placed at this level, the new goods will arrive before
the firm runs out of goods to sell. This is the point fixed between the maximum and
minimum stock levels and at this time, it is essential to initiate purchase action for fresh
supplies of materials. In order to cover the abnormal usage of materials or unexpected
delay in delivery of fresh supplies, this point will usually be fixed slightly higher than the
minimum stock level. The following factors are considered while fixing the re-order
level: (i) maximum usage of materials, (ii) maximum lead time, (iii) maximum stock
level and (iv) minimum stock level. The term lead time refers to the time normally taken
in receiving the delivery of inventory after the order has been placed. Re-order level =
Average usage x Lead time. Safety Stock = Average usage x Period of Safety

 ABC Analysis
ABC analysis is the technique of exercising selective control over inventory
items. It is a method of material control according to value. It is based on the assumption
that a firm should not exercise the same degree of control on all items of inventory. The
basic principle is that high value items are more closely controlled than the low value
items. Accordingly, the materials are grouped according to the value and frequency of
replenishment during a period. Category ‘A’ items Constitutes small percentage of the
total items, but having higher values. Category ‘B’ items More percentage of the total
items, but having medium values. Category ‘C’ items High percentage of the total items,
but having low values.
 Inventory Turnover Ratios
Turnover ratio of each item of inventory can be calculated on the basis of the
following formula: Inventory turnover ratio = Cost of goods consumed/sold during the
period Average inventory held during the period Comparison of inventory turnover ratios
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of different items of inventory with the ratios of the earlier years as well as with each
other reveals the following four types of inventories. Slow moving inventories: These
refer to inventories, which have a low turnover ratio. This type of inventories is to be kept
at the lowest level. Dormant inventories: These are inventories, which have no demand.
These may be scrapped and sold for some value or may be kept if there is good chances
of future demand. Obsolete inventories: These are inventories, which are no longer in
demand because they have become out of date. They should be discarded or scrapped.
Fast moving inventories: These are items with good demand. Special care should be
taken in respect of these items of inventories, so that production or sales do not suffer on
account of their shortage.

Apart from the above inventory management techniques, there are other selective control
measures as follows:

 VED analysis( Vital, Essential, Desirable),

 Just-in-Time (JIT), SDE analysis for procurement of materials(Scarce, Difficult, Easy),
 XYZ analysis for value of items in storage(X= items whose inventory values are high, Y
= inventory values are medium and Z = inventory values are low),
 SOS analysis of raw materials (Seasonal items, Off-Seasonal items),
 GOLF analysis of supply of materials (Government suppliers, Open suppliers, Local
suppliers, Foreign sources) and
 HML analysis for unit price of material(High, Medium, Low).

Conclusion
So far I have explained inventories with its different categories. This is followed by benefits,
risks and cost of holding inventories.