Master Mba 2018 Semester 2

MANUAL
MASTERS OF
BUSINESS ADMINISTRATION
SCHEME – 2018
Semester 2
1 MBA, 2018. SEMESTER 2

Compiled by VJES,(www.VJES.ORG) Disclaimer : - This is for internal circulation only.
INDEX
SUBJECT CODE SUBJECT PAGE

BUSINESS ANALYTICS FOR
MBA 201-18
DECISION MAKING
LEGAL ENVIRONMENT FOR
MBA 202-18
BUSINESS
MBA 203-18 MARKETING MANAGEMENT
HUMAN RESOURCE
MBA 204-18
MANAGEMENT
PRODUCTION AND
MBA 205-18
OPERATIONS MANAGEMENT
CORPORATE FINANCE AND
MBA 206-18
INDIAN FINANCIAL SYSTEM
ENTREPRENEURSHIP AND
MBA 207-18
PROJECT MANAGEMENT
COMPUTER APPLICATIONS
MBAGE 201-18
FOR BUSINESS

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objective of compilation of this book is not to compete with authors
of foreign or Indian origin having experience in the same trades, but is
solely for the purpose of educating students and not for any profit
purpose. The materials compile by the authors are sheer experiences
faced by the authors and has independent views and researches
carried out to suit Indian and International requirements.
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MBA 2018
SUB CODE : MBA 201- 18
SUBJECT NAME:
BUSINESS ANALYTICS FOR DECISION
MAKING

MBA 201-18 Business Analytics for Decision Making
Unit I
Introduction to Statistics: Meaning, Importance, Applications of
inferential statistics in managerial decision making. Collection of
Data: concept of primary data and secondary data, sources of primary
data and secondary data, Classification and Tabulation of Data:
Concept and types of classification, construction of frequency
distributions, tabulation of data: role of tabulation, parts of table, rules
of tabulation, review of table, types of table.
Sampling: Concept, definitions, census and sampling, probability and
non probability methods of sampling, relationship between sample
size and errors.
Unit II
Sampling Distributions: Concept and standard error.
Hypothesis Testing: Formulation of hypothesis, procedure of
hypothesis testing, errors in testing of hypothesis, tests of significance
for large samples, tests of significance for small samples, application
of t-test, Z-test, F-test and Chi-square test and Goodness of fit,
ANOVA.
Techniques of association of attributes.
Unit III
Business Forecasting: Introduction, Role of forecasting in business,
Steps in forecasting and methods of forecasting.
Correlation: Partial and Multiple correlation.
Regression Analysis: Multiple regression analysis, Testing the
assumptions of regression: multicolinearity, heteroscedasticity and
autocorrelation.
Unit IV
Index Number: Definition, importance of index number in
managerial decision making, methods of construction, tests of
consistency, base shifting, splicing and deflation, problems in
construction.
Time Series Analysis: Meaning, component and, methods of time
series analysis. Trend analysis: Least square method, linear and non
linear equations, applications of time series in business decision
making.

UNIT1
‘Statistics’ means numerical information expressed in quantitative
terms. This information may relate to objects, subjects, activities,
phenomena, or regions of space. As a matter of fact, data have no
limits as to their reference, coverage, and scope. At the macro level,
these are data on gross national product and shares of agriculture,
manufacturing, and services in GDP (Gross Domestic Product).
AN INTRODUCTION TO BUSINESS STATISTICS
At the micro level, individual firms, howsoever small or large,
produce extensive statistics on their operations. The annual reports of
companies contain variety of data on sales, production, expenditure,
inventories, capital employed, and other activities. These data are
often field data, collected by employing scientific survey techniques.
Unless regularly updated, such data are the product of a one-time
effort and have limited use beyond the situation that may have called
for their collection. A student knows statistics more intimately as a
subject of study like economics, mathematics, chemistry, physics, and
others. It is a discipline, which scientifically deals with data,
and is often described as the science of data. In dealing with statistics
as data, statistics has developed appropriate methods of collecting,
presenting, summarizing, and analysing data, and thus consists of a
body of these methods.
MEANING AND DEFINITIONS OF STATISTICS
In the beginning, it may be noted that the word ‘statistics’ is used
rather curiously in two senses plural and singular. In the plural sense,
it refers to a set of figures or data. In the singular sense, statistics
refers to the whole body of tools that are used to collect data, organise
and interpret them and, finally, to draw conclusions from them.
It should be noted that both the aspects of statistics are important if
the quantitative data are to serve their purpose. If statistics, as a
subject, is inadequate and consists of poor methodology, we could not
know the right procedure to extract from the data the information they
contain. Similarly, if our data are defective or that they are inadequate
or inaccurate, we could not reach the right conclusions even though
our subject is well developed.

A.L. Bowley has defined statistics as: (i) statistics is the science of
counting, (ii) Statistics may rightly be called the science of averages,
and (iii) statistics is the science of measurement of social organism
regarded as a whole in all its manifestations. Boddington defined as:
Statistics s the science of estimates and probabilities. Further, W.I.
King has defined Statistics in a wider context, the science of Statistics
is the method of judging collective, natural or social phenomena from
the
results obtained by the analysis or enumeration or collection of
estimates.
Seligman explored that statistics is a science that deals with the
methods of collecting, classifying, presenting, comparing and
interpreting numerical data collected to throw some light on any
sphere of enquiry. Spiegal defines statistics highlighting its role in
decision-making particularly under uncertainty, as follows: statistics
is concerned with scientific method for collecting, organising, summa
rising, presenting and analyzing data as well as drawing valid
conclusions and making reasonable decisions on the basis of such
analysis. According to Prof. Horace Secrist, Statistics is the aggregate
of facts, affected to a marked extent by multiplicity of causes,
numerically expressed, enumerated or estimated according to
reasonable standards of accuracy, collected in a systematic manner for
a pre-determined purpose, and placed in relation to each other.
From the above definitions, we can highlight the major characteristics
of statistics as follows:
(i) Statistics are the aggregates of facts. It means a single figure is not
statistics. For example, national income of a country for a single year
is not statistics but the same for two or more years is statistics.
(ii) Statistics are affected by a number of factors. For example, sale of
a product depends on a number of factors such as its price, quality,
competition, the income of the consumers, and so on.
(iii) Statistics must be reasonably accurate. Wrong figures, if
analysed, will lead to erroneous conclusions. Hence, it is necessary
that conclusions must be based on accurate figures.

(iv) Statistics must be collected in a systematic manner. If data are
collected in a haphazard manner, they will not be reliable and will
lead to misleading conclusions.
(v) Collected in a systematic manner for a pre-determined purpose .
(vi) Lastly, Statistics should be placed in relation to each other. If one
collects data unrelated to each other, then such data will be confusing
and will not lead to any logical conclusions. Data should be
comparable over time and over space.
TYPES OF DATA AND DATA SOURCES
Statistical data are the basic raw material of statistics. Data may relate
to an activity of our interest, a phenomenon, or a problem situation
under study. They derive as a result of the process of measuring,
counting and/or observing. Statistical data, therefore, refer to those
aspects of a problem situation that can be measured, quantified,
counted, or classified. Any object subject phenomenon, or activity
that generates data through this process is termed as a variable. In
other words, a variable is one that shows a degree of variability when
successive measurements are recorded.
In statistics, data are classified into two broad categories: quantitative
data and qualitative data. This classification is based on the kind of
characteristics that are measured.
Quantitative data are those that can be quantified in definite units of
measurement. These refer to characteristics whose successive
measurements yield quantifiable observations. Depending on the
nature of the variable observed for measurement, quantitative data can
be further categorized as continuous and discrete data.
Obviously, a variable may be a continuous variable or a discrete
variable.
(i) Continuous data represent the numerical values of a continuous
variable. A continuous variable is the one that can assume any value
between any two points on a line segment, thus representing an
interval of values. The values are quite precise and close to each
other, yet distinguishably different. All characteristics such as weight,
length, height, thickness, velocity, temperature, tensile strength, etc.,
represent continuous variables. Thus, the data recorded on these and
similar other characteristics are called continuous data. It may be

noted that a continuous variable assumes the finest unit of
measurement.
Finest in the sense that it enables measurements to the maximum
degree of precision.
(ii) Discrete data are the values assumed by a discrete variable. A
discrete variable is the one whose outcomes are measured in fixed
numbers. Such data are essentially count data. These are derived from
a process of counting, such as the number of items possessing or not
possessing a certain characteristic.
The number of customers visiting a departmental store everyday, the
incoming flights at an airport, and the defective items in a
consignment received for sale, are all examples of discrete data.
Qualitative data refer to qualitative characteristics of a subject or an
object. A characteristic is qualitative in nature when its observations
are defined and noted in terms of the presence or absence of a certain
attribute in discrete numbers. These data are further classified as
nominal and rank data.
(i) Nominal data are the outcome of classification into two or more
categories of items or units comprising a sample or a population
according to some quality characteristic. Classification of students
according to sex (as males and females), of workers according to skill
(as skilled, semi-skilled, and unskilled), and of employees according
to the level of education (as matriculates,
undergraduates, and post-graduates), all result into nominal data.
Given any such basis of classification, it is always possible to assign
each item to a particular class and make a summation of items
belonging to each class. The count data so obtained are called
nominal data.
(ii) Rank data, on the other hand, are the result of assigning ranks to
specify order in terms of the integers 1,2,3, ..., n. Ranks may be
assigned according to the level of performance in a test. a contest, a
competition, an interview, or a show. The candidates appearing in an
interview, for example, may be assigned ranks in integers ranging
from I to n, depending on their performance in the interview. Ranks
so assigned can be viewed as the continuous values of a variable
involving performance as the quality characteristic.

Data sources could be seen as of two types, viz., secondary and
primary. The two can be defined as under:
(i) Secondary data: They already exist in some form: published or
unpublished - in an identifiable secondary source. They are, generally,
available from published source(s), though not necessarily in the form
actually required.
(ii) Primary data: Those data which do not already exist in any
form, and thus have to be collected for the first time from the primary
source(s). By their very nature, these data require fresh and first-time
collection covering the whole population or a sample drawn from it.
TYPES OF STATISTICS
There are two major divisions of statistics such as descriptive
statistics and inferential statistics. The term descriptive statistics deals
with collecting, summarizing, and simplifying data, which are
otherwise quite unwieldy and voluminous. It seeks to achieve this in a
manner that meaningful conclusions can be readily drawn from the
data. Descriptive statistics may thus be seen as comprising methods of
bringing out and highlighting the latent characteristics present in a set
of numerical data. It not only facilitates an understanding of the data
and systematic reporting thereof in a manner; and also makes them
amenable to further discussion, analysis, and interpretations.
The first step in any scientific inquiry is to collect data relevant to the
problem in hand. When the inquiry relates to physical and/or
biological sciences, data collection is normally an integral part of the
experiment itself. In fact, the very manner in which an experiment is
designed, determines the kind of data it would require and/or
generate. The problem of identifying the nature and the kind of the
relevant data is thus automatically resolved as soon as the design of
experiment is finalized. It is possible in the case of physical sciences.
In the case of social sciences, where the
required data are often collected through a questionnaire from a
number of carefully selected respondents, the problem is not that
simply resolved. For one thing, designing the questionnaire itself is a
critical initial problem. For another, the number of respondents to be
accessed for data collection and the criteria for selecting them has
their own implications and importance for the quality of results

obtained. Further, the data have been collected, these are assembled,
organized, and presented in the form of appropriate tables to make
them readable. Wherever needed, figures,
diagrams, charts, and graphs are also used for better presentation of
the data. A useful tabular and graphic presentation of data will require
that the raw data be properly classified in accordance with the
objectives of investigation and the relational analysis to be carried
out. .
A well thought-out and sharp data classification facilitates easy
description of the hidden data characteristics by means of a variety of
summary measures. These include measures of central tendency,
dispersion, skewness, and kurtosis, which constitute the essential
scope of descriptive statistics. These form a large part of the subject
matter of any basic textbook on the subject, and thus they are being
discussed in that order here as well.
Inferential statistics, also known as inductive statistics, goes beyond
describing a given problem situation by means of collecting,
summarizing, and meaningfully presenting the related data. Instead, it
consists of methods that are used for drawing inferences, or making
broad generalizations, about a totality of observations on the basis of
knowledge about a part of that totality. The totality of observations
about which an inference may be drawn, or a generalization made, is
called a population or a universe. The part of totality, which is
observed for data collection and analysis to gain knowledge about the
population, is called a sample.
The desired information about a given population of our interest; may
also be collected even by observing all the units comprising the
population. This total coverage is called census. Getting the desired
value for the population through census is not always feasible and
practical for various reasons. Apart from time and money
considerations making the census operations prohibitive, observing
each individual unit of the population with reference to any data
characteristic may at times involve even destructive testing. In such
cases, obviously, the only recourse available is to
employ the partial or incomplete information gathered through a
sample for the purpose. This is precisely what inferential statistics

does. Thus, obtaining a particular value from the sample information
and using it for drawing an inference about the entire population
underlies the subject matter of inferential statistics. Consider a
situation in which one is required to know the average body weight of
all the college students in a given cosmopolitan city during a certain
year. A quick and easy way to do this is to record the weight of only
500 students, from out of a total strength of, say, 10000, or an
unknown total strength, take the average, and use this average based
on incomplete weight data to represent the average body weight of all
the college students. In a different situation, one may have to repeat
this exercise for some future year and use the quick estimate of
average body weight for a comparison. This may be needed, for
example, to decide whether the weight of the college students has
undergone a significant change over the years compared.
Inferential statistics helps to evaluate the risks involved in reaching
inferences or generalizations about an unknown population on the
basis of sample information. for example, an inspection of a sample of
five battery cells drawn from a given lot may reveal that all the five
cells are in perfectly good condition. This information may be used to
conclude that the entire lot is good enough to buy or not.
Since this inference is based on the examination of a sample of
limited number of cells, it is equally likely that all the cells in the lot
are not in order. It is also possible that all the items that may be
included in the sample are unsatisfactory. This may be used to
conclude that the entire lot is of unsatisfactory quality, whereas the
fact may indeed be otherwise. It may, thus, be noticed that there is
always a risk of an inference about a population being incorrect when
based on the knowledge of a limited sample. The rescue in such
situations lies in evaluating such risks. For this, statistics provides the
necessary methods. These centres on quantifying in probabilistic term
the chances
of decisions taken on the basis of sample information being incorrect.
This requires an understanding of the what, why, and how of
probability and probability distributions to equip ourselves with
methods of drawing statistical inferences and estimating the degree of
reliability of these inferences.

SCOPE OF STATISTICS
Apart from the methods comprising the scope of descriptive and
inferential branches of statistics, statistics also consists of methods of
dealing with a few other issues of specific nature. Since these
methods are essentially descriptive in nature, they have been
discussed here as part of the descriptive statistics. These are mainly
concerned with the following:
(i) It often becomes necessary to examine how two paired data sets
are related. For example, we may have data on the sales of a product
and the expenditure incurred on its advertisement for a specified
number of years. Given that sales and advertisement expenditure are
related to each other, it is useful to examine the nature of relationship
between the two and quantify the degree of that
relationship. As this requires use of appropriate statistical methods,
these falls under the purview of what we call regression and
correlation analysis. (ii) Situations occur quite often when we require
averaging (or totalling) of data on prices and/or quantities expressed
in different units of measurement. For example, price of cloth may be
quoted per meter of length and that of wheat
per kilogram of weight. Since ordinary methods of totalling and
averaging do not apply to such price/quantity data, special techniques
needed for the purpose are developed under index numbers.
(iii) Many a time, it becomes necessary to examine the past
performance of an activity with a view to determining its future
behaviour. For example, when engaged in the production of a
commodity, monthly product sales are an important measure of
evaluating performance. This requires compilation and analysis of
relevant sales data over time. The more complex the activity, the
more varied the data requirements. For profit maximising and future
sales planning, forecast of likely sales growth rate is crucial. This
needs careful collection and analysis of past sales data. All such
concerns are taken care of under time series analysis.
(iv) Obtaining the most likely future estimates on any aspect(s)
relating to a business or economic activity has indeed been engaging
the minds of all concerned. This is particularly important when it
relates to product sales and demand, which serve the necessary basis

of production scheduling and planning. The regression, correlation,
and time series analyses together help develop the basic methodology
to do the needful. Thus, the study of methods and techniques of
obtaining the likely estimates on business/economic variables
comprises the scope of what we do under business forecasting.
Keeping in view the importance of inferential statistics, the scope of
statistics may finally be restated as consisting of statistical methods
which facilitate decision-making under conditions of uncertainty.
While the term statistical methods is often used to cover the subject of
statistics as a whole, in particular it refers to methods by which
statistical data are analysed, interpreted, and the inferences drawn for
decisionmaking.
Though generic in nature and versatile in their applications, statistical
methods have come to be widely used, especially in all matters
concerning business and economics. These are also being increasingly
used in biology, medicine, agriculture, psychology, and education.
The scope of application of these methods has started opening and
expanding in a number of social science disciplines as well. Even a
political scientist finds them of increasing relevance for examining the
political behaviour and it is, of course, no surprise to find even
historians statistical data, for history is essentially past data presented
in certain actual format.
IMPORTANCE OF STATISTICS IN BUSINESS
There are three major functions in any business enterprise in which
the statistical methods are useful. These are as follows:
(i) The planning of operations: This may relate to either special
projects or to the recurring activities of a firm over a specified period.
(ii) The setting up of standards: This may relate to the size of
employment, volume of sales, fixation of quality norms for the
manufactured product, norms for the daily output, and so forth. (iii)
The function of control: This involves comparison of actual
production achieved against the norm or target set earlier. In case the
production has fallen short of the target, it gives remedial measures so
that such a deficiency does not occur again.

A worth noting point is that although these three functions-planning
of operations, setting standards, and control-are separate, but in
practice they are very much interrelated.
Different authors have highlighted the importance of Statistics in
business. Forinstance, Croxton and Cowden give numerous uses of
Statistics in business such as project planning, budgetary planning and
control, inventory planning and control, quality control, marketing,
production and personnel administration. Within these also they have
specified certain areas where Statistics is very relevant. Another
author, Irwing W. Burr, dealing with the place of statistics in an
industrial organisation, specifies a number of areas where statistics is
extremely useful. These are: customer
wants and market research, development design and specification,
purchasing, production, inspection, packaging and shipping, sales and
complaints, inventory and maintenance, costs, management control,
industrial engineering and research. Statistical problems arising in the
course of business operations are multitudinous. As such, one may do
no more than highlight some of the more important ones to emphasis
the relevance of statistics to the business world. In the sphere of
production, for example, statistics can be useful in various ways.
Statistical quality control methods are used to ensure the production
of quality goods. Identifying and rejecting defective or substandard
goods achieve this. The sale targets can be fixed on the basis of sale
forecasts, which are done by using varying methods of forecasting.
Analysis of sales affected against the targets set earlier would indicate
the deficiency in achievement, which may be on account of several
causes: (i) targets were too high and unrealistic (ii) salesmen's
performance has been poor (iii) emergence of increase in competition
(iv) poor quality of company's product, and so on. These factors can
be further investigated.
Another sphere in business where statistical methods can be used is
personnel management. Here, one is concerned with the fixation of
wage rates, incentive norms and performance appraisal of individual
employee. The concept of productivity is very relevant here. On the
basis of measurement of productivity, the productivity bonus is

awarded to the workers. Comparisons of wages and productivity are
undertaken in order to ensure increases in industrial productivity.
Statistical methods could also be used to ascertain the efficacy of a
certain product, say, medicine. For example, a pharmaceutical
company has developed a new medicine in the treatment of bronchial
asthma. Before launching it on commercial basis, it wants to ascertain
the effectiveness of this medicine. It undertakes an experimentation
involving the formation of two comparable groups of asthma patients.
One group is given this new medicine for a specified period and the
other one is treated with the usual medicines. Records are maintained
for the two groups for
the specified period. This record is then analysed to ascertain if there
is any significant difference in the recovery of the two groups. If the
difference is really significant statistically, the new medicine is
commercially launched.
LIMITATIONS OF STATISTICS
Statistics has a number of limitations, pertinent among them are as
follows:
(i) There are certain phenomena or concepts where statistics cannot be
used. This is because these phenomena or concepts are not amenable
to measurement. For example, beauty, intelligence, courage cannot be
quantified. Statistics has no place in all such cases where
quantification is not possible.
(ii) Statistics reveal the average behaviour, the normal or the general
trend. An application of the 'average' concept if applied to an
individual or a particular situation may lead to a wrong conclusion
and sometimes may be disastrous. For example, one may be
misguided when told that the average depth of a river from one bank
to the other is four feet, when there may be some points in between
where its depth is far more than four feet. On this understanding, one
may enter those points having greater depth, which may be hazardous.
(iii) Since statistics are collected for a particular purpose, such data
may not be relevant or useful in other situations or cases. For
example, secondary data (i.e., data originally collected by someone
else) may not be useful for the other person.

(iv) Statistics are not 100 per cent precise as is Mathematics or
Accountancy. Those who use statistics should be aware of this
limitation.
(v) In statistical surveys, sampling is generally used as it is not
physically possible to cover all the units or elements comprising the
universe. The results may not be appropriate as far as the universe is
concerned. Moreover, different surveys based on the same size of
sample but different sample units may yield different results.
(vi) At times, association or relationship between two or more
variables is studied in statistics, but such a relationship does not
indicate cause and effect' relationship. It simply shows the similarity
or dissimilarity in the movement of the two variables. In such cases, it
is the user who has to interpret the results carefully, pointing out the
type of relationship obtained.
(vii) A major limitation of statistics is that it does not reveal all
pertaining to a certain phenomenon. There is some background
information that statistics does not cover. Similarly, there are some
other aspects related to the problem on hand, which are also not
covered. The user of Statistics has to be well informed and should
interpret Statistics keeping in mind all other aspects having relevance
on the given problem.
Apart from the limitations of statistics mentioned above, there are
misuses of it. Many people, knowingly or unknowingly, use statistical
data in wrong manner. Let us see what the main misuses of statistics
are so that the same could be avoided when one has to use statistical
data. The misuse of Statistics may take several forms some of which
are explained below.
(i) Sources of data not given: At times, the source of data is not
given. In the absence of the source, the reader does not know how far
the data are reliable. Further, if he wants to refer to the original
source, he is unable to do so.
(ii) Defective data: Another misuse is that sometimes one gives
defective data. This may be done knowingly in order to defend one's
position or to prove a particular point. This apart, the definition used
to denote a certain phenomenon may be defective. For example, in
case of data relating to unemployed persons, the definition may

include even those who are employed, though partially. The question
here is how far it is justified to include partially employed persons
amongst unemployed ones.
(iii) Unrepresentative sample: In statistics, several times one has to
conduct a survey, which necessitates to choose a sample from the
given population or universe. The sample may turn out to be
unrepresentative of the universe. One may choose a sample just on the
basis of convenience. He may collect the desired information from
either his friends or nearby respondents in his
neighbourhood even though such respondents do not constitute a
representative sample.
(iv) Inadequate sample: Earlier, we have seen that a sample that
isunrepresentative of the universe is a major misuse of statistics. This
apart, at times one may conduct a survey based on an extremely
inadequate sample.
For example, in a city we may find that there are 1, 00,000
households. When we have to conduct a household survey, we may
take a sample of merely 100 households comprising only 0.1 per cent
of the universe. A survey based on such a small sample may not yield
right information.
(v) Unfair Comparisons: An important misuse of statistics is making
unfair comparisons from the data collected. For instance, one may
construct an index of production choosing the base year where the
production was much less.
Then he may compare the subsequent year's production from this low
base. Such a comparison will undoubtedly give a rosy picture of the
production though in reality it is not so. Another source of unfair
comparisons could be when one makes absolute comparisons instead
of relative ones. An absolute comparison of two figures, say, of
production or export, may show a good increase, but in relative terms
it may turnout to be very negligible. Another example of unfair
comparison is when the population in two cities is different, but a
comparison of overall death rates and deaths by a particular disease is
attempted. Such a comparison is wrong. Likewise, when data are not
properly classified or when changes in the composition of population

in the two years are not taken into consideration, comparisons of such
data would be unfair as they would lead to misleading conclusions.
(vi) Unwanted conclusions: Another misuse of statistics may be on
account of unwarranted conclusions. This may be as a result of
making false assumptions. For example, while making projections of
population in the next five years, one may assume a lower rate of
growth though the past two years indicate otherwise. Sometimes one
may not be sure about the changes in business
environment in the near future. In such a case, one may use an
assumption that may turn out to be wrong. Another source of
unwarranted conclusion may be the use of wrong average. Suppose in
a series there are extreme values, one is too high while the other is too
low, such as 800 and 50. The use of an arithmetic average in such a
case may give a wrong idea. Instead, harmonic mean would be proper
in such a case.
(vii) Confusion of correlation and causation: In statistics, several
times one has to examine the relationship between two variables. A
close relationship between the two variables may not establish a
cause-and-effect-relationship in the sense that one variable is the
cause and the other is the effect. It should be taken as something that
measures degree of association rather than try to find out causal
relationship.
Census Vs. sampling method
Sample is a part of the population from which it is selected. The
process of selecting a sample is known as sampling. Thus, the
sampling theory is a study of relationship that exists between the
population and the samples drawn from the population. The complete
enumeration, popularly known as census, may not be feasible either
due to non-availability of time or because of high cost involved.
Therefore, it becomes essential to draw inferences for the population
on the basis of sample information. Thus, sampling helps us to get as
much information as possible of the whole universe. The sampling
also helps us in determining the reliability of the estimates. This can
be done by drawing samples from the same parent population and
comparing the results obtained from different samples. In a survey of
the entire population, data is collected from every elementary unit of

the population. Suppose, one is studying the wage structure of the
coal mining industry in the country, then one approach is to collect
the data on wages of every worker in the coal industry. From this
data, one can calculate the various characteristics of the population,
such as average wage, the range and the variance, etc. This is referred
as census survey. The advantages of the census approach are every
unit of the population is considered and the respective data on the
various characteristics are compiled,
the analysis made on the basis of census data is very accurate and
reliable, and in one time studies of special importance, only census
method is adopted in order to get accurate and reliable data. The data
collected by this method becomes a data base for all future studies.
This is one of the reasons why population data are collected once in a
decade by the census method. Although there are many advantages
with the census method, the cost, effort and the time required to
conduct census survey is very large, unless the population is very
small, and in many cases it is so prohibitive that one rarely uses this
method in surveys.
Sampling involves an examination of a small portion of the
elementary units in a population. Although, a census operation gives a
more reliable data, sampling method is more desired when 1.1. the
population is very large, i.e., infinite and it would be impossible to
conduct census surveys; 2.1. when quick results are required it would
be appropriate to conduct sample surveys rather than census surveys;
3.1. in studies involving destruction of the elementary units under
study, it would only be appropriate to go for sample testing. Items
such as light bulbs and ammunition often must be destroyed as a part
of testing process; 4.1. cost of conducting surveys would be very
prohibitive in census method, and therefore, it is advisable to carry
out a sample survey, and lastly; and 5.1. some times accuracy may be
lost because of the large size of the population. Sampling involves a
small portion of the population and therefore, would involve very few
people for conducting surveys and for data collection and
compilation. This would not be so in the census method and the
chances of committing errors would increase. As the sampling
involves less time and money, it would be possible to give attention to

different characteristics of the elementary units. A sample using same
money and time can produce a detailed study of lesser number of
units. The process of sampling involves selecting a sample, collecting
all relevant information, and finally drawing conclusions about the
population from which the sample has been drawn.
Definitions The surveys are concerned with the attributes of certain
entities, such as business enterprises, human beings, etc. The
attributes that are the object of the study are known as characteristics
and the units possessing them are called the elementary units. The
aggregate of elementary units to which the conclusions of the study
apply is termed as population/universe, and the units that form the
basis of the sampling process are called sampling units. The sampling
unit may be an elementary unit. The sample is defined as an aggregate
of sampling units actually chosen in obtaining a representative subset
from which inferences about the population are drawn. The frame— a
list or directory, defines all the sampling units in the universe to be
covered. This frame is either constructed for the purpose of a
particular survey or may consist of previously available description of
the population; the latter is the commonly used method. For example,
telephone directory can be used as a frame for conducting opinion
surveys in a city or locality. In order that, sampling results reflect the
characteristics of the population, it is necessary that the sample
selected for study should be 1.1. Truly representative, i.e., the selected
sample truly represent the universe so that the results can be
generalised;
2.1. Adequate, i.e., the size of the sample or the sample size should be
adequate enough to represent the various characteristics of the
universe;
3.1. Independent, i.e. the elementary units selected should be
independent of one another and all units of the population should have
the same chance of being selected in the sample; and lastly
4.1. Homogeneous, i.e., there should not be any basic difference
between the characteristics of the units in the sample and that of the
population. This means that if two or more samples are drawn from
the same population, the results should be more or less identical.

Probability samples vs. non-probability samples A probability
sample is one for which the inclusion or exclusion of any individual
element of the population depends upon the application of probability
methods and not on a personal judgement. It is so designed and drawn
that the probability of inclusion of an element is known. The essential
feature of drawing such a sample is the randomness. As against the
probability sample, we have a variety of other samples, termed as
judgement samples, purposive samples, quota samples, etc. These
samples have one common distinguishing feature: personal judgement
rather than the random procedure to determine the composition of
what is to be taken as a representative sample. The judgement affects
the choice of the individual elements. All such samples are non-
random, and no objective measure of precision may be attached to the
results arrived at.
In a probability sampling, it is possible to estimate the error in the
estimates and they can be minimized also. It is also possible to
evaluate the relative efficiency of the various probability sampling
designs. Probability sampling does not depend upon the detailed
information about population for its effectiveness. However,
probability sampling requires a high level of skill and experience for
its use. It also requires sufficient time and money to execute.
Non-probability sampling is a procedure of selecting a sample
without the use of probability or randomisation. It is based on
convenience, judgement, etc. The major difference between the two
approaches is that it is possible to estimate the sampling variability in
the case of probability sampling while it is not possible to estimate the
same in the non-probability sampling. The classification of various
probability and non-probability methods.
POPULATION SAMPLING
Probability Samples Non probability Samples •Simple Random
Sampling •Convenience Sampling •Stratified Random Sampling
•Quota Sampling •Cluster Sampling or •Judgement Sampling
Multistage Sampling •Systematic Sampling .
Classification of sampling schemes
Probability Sampling Methods The various probability sampling
methods are described as under:

(a) Simple random sampling method In simple random sampling,
drawing of elements from the population is random and the choice of
an element is made in such a way that every element has the same
probability of being chosen. When the sample is so selected, every
possible set of elements has the same chance of being drawn. With N,
population size, fairly large, the number of such possible sets of size n
is of course very large. This number is given by NCn. Of course, it is
unnecessary in a specific case to compute the number of possible sets
of stated size that might be drawn from a given population, but the
process of sample selection should be such that the probability of
selection is the same for every such set.
The objective is to achieve randomness in drawing the individual
elements of a sample for ensuring that all possible samples have
the same chance of being selected.
If we are to draw from a population containing N elementary units,
the elementary unit also being a sampling unit, it is necessary that
each of the N units should be individually numbered or otherwise
distinctively designed. One of the approaches for drawing random
sample of size n from a population of N units is to draw n cards from
N cards which are numbered from 1 to N and mixed thoroughly. The
sample size n, thus drawn, would constitute a simple random sample
(SRS). Another popular method of selecting a random sample is by
lottery method. In this method all the elements are named or
numbered on a small slip of paper of identical shape and size. These
slips are folded identically and mixed up well in a container. Number
of slips of desired sample size is selected blindly from this container.
Thus, the selection of elementary units depends purely on chance and
no personal bias exists. We shall illustrate this method of selection of
a sample with the following example: Suppose the warden of a
student’s hostel with 200 occupants wants to constitute a welfare
committee with the members randomly selected. The lottery method
of selecting these five members from a group of 200 would be first to
prepare 200 slips of identical shape and size and write the name of
each student on a slip. Fold these 200 slips identically and mix them
well in a container. Then select five folded slips, from the container at
random. The five students so selected would constitute a welfare

committee of the hostel. There are, however, some difficulties in these
procedures. For, if N is large, the task becomes physically difficult.
So it is desirable to use better methods for ensuring randomness. One
such method is the use of random number tables. Use of random
number tables If the N elements of a total population are numbered
serially from 1 to N, a random sample may be most readily and
reliably drawn by using a table of random numbers. Such tables
enable us to select n numbers at random from the full list of serial
numbers from 1 to N. In a random number table, digits in each
column are in random order and so are the digits in each row. As the
arrangement is random in all directions, it makes no difference where
we begin in our selection of random numbers from such a table.
However, the column arrangement is generally found more
convenient for references. Several random number tables are available
for use. These numbers have been adequately tested for randomness.
Among them, the most popular ones are:
1.1. Tippett’s (1927) 10,400 sets of four-digited random numbers;
2.1. Fisher and Yates (1938) table of random numbers with 1,500
sets of ten-digited random numbers; and
3.1. Rand Corporation (1955) table of random numbers of 2,00,000
sets of five-digited random numbers. Tippet’s table of random
numbers is most popularly used in practice. Given below are the first
forty sets from Tippet’s table as an illustration of the general
appearance of random numbers: 2952 6641 3992 9792 7969 5911
3170 5624 4167 9524 1545 1396 7203 5356 1300 2693 2670 7483
3408 2762 3563 1089 6913 7691 0560 5246 1112 6107 6008 8125
4233 8776 2754 9143 1405 9025 7002 6111 8816 6446
Tippett’s numbers have been subjected to numerous tests and used in
many investigations and their randomness has been well established
for all practical purposes. An example to illustrate how Tippett’s table
of random numbers may be used is given below. Suppose ten
numbers from out of 0 and 80 are required. We start anywhere in the
table and write down the numbers in pairs. The table can be read
horizontally, vertically, diagonally or in any methodical way. Starting
with the first and reading horizontally first we obtain 29, 52, 66, 41,
39, 92, 97, 92, 79, 69, 59, 11, 31, 70, 56, 24, 41, 67 and so on.

Ignoring the numbers greater than 80, we obtain for one purpose ten
random numbers, namely 29, 52, 66, 41, 39, 79, 69, 59, 11 and 31.
The sampling procedure described above is quite satisfactory for a
small population. With a large population, the process of
identification of numbers to each elementary sampling unit becomes
very prohibitive with respect to both time and money. Moreover, the
population is often geographically spread out or composed of clearly
identified strata possessing unique characteristics. Whenever any of
the above situations arise, alternative sampling schemes that are
sophisticated combinations of simple random sampling provide
significantly better results for the same expenditure and time. As a
result, the simple random sampling method is not very frequently
used in practice. However, the simple random sampling scheme is the
basis of any other probabilistic sampling schemes.
(b) Stratified random sampling method In simple random sampling,
the population to be sampled is treated as homogeneous and the
individual elements are drawn at random from the whole universe.
However, it is often possible and desirable to classify the population
into distinctive classes or strata and then obtain a sample by drawing
at random the specified number of sampling units from each of the
classes thus constructed. This may be desirable because of our interest
in the distinct classes of the universe as a whole. In stratified random
sampling, the population is sub-divided into strata before the sample
is drawn. Strata are so designed that they should not overlap. A
sample of specified size is drawn at random from the sampling units
that make up each stratum. If a given stratum is of our interest, the
corresponding sub-sample provides the basis for estimates concerning
the attributes of the population stratum, or sub-universe from which it
is drawn. The total of subsamples constitutes the aggregate sample on
which estimates of attributes of the entire population are based.
Stratified samples may be either proportional or non-proportional. In
a proportional stratified sampling, the number of elements to be
drawn from each stratum is proportional to the size of that stratum
compared with the population. For example, if a sample size of 500
elementary units have to be drawn from a population with 10,000
units divided in four strata in the following way:

Population size Sample size Stratum I = 2000 500 × 0.2 = 100
Stratum II = 3000 500 × 0.3 = 150 Stratum III = 4000 500 × 0.4 =
200 Stratum IV = 1000 500 × 0.1 = 50 Total 10000 500 Thus, the
elements to be drawn from each stratum would be 100, 150, 200 and
50 respectively. Proportional stratification yields a sample that
represents the population with respect to the proportion in each
stratum in the population. Proportional stratified sampling yields
satisfactory results if the dispersion in the various strata is of
proportionately the same magnitude. If there is a significant
difference in dispersion from stratum to stratum, sample estimates
will be much more efficient if non-proportional stratified random
sampling is used. Here, equal numbers of elements are selected from
each stratum regardless of how the stratum is represented in the
population. Thus, in the earlier example, an equal number, i.e., 125, of
elementary units will be drawn to constitute the sample. A sample
drawn by stratified random sampling scheme ensures a representative
sample as the population is first divided into various strata and then a
sample is drawn from each stratum. Stratified random sampling
also ensures greater accuracy and it is maximum if each stratum is
formed in such a way that it consists of uniform or homogeneous
items. Compared with a simple random sample, a stratified sample
can be more concentrated geographically, i.e., the elementary units
from different strata may be selected in such a way that all of them
are located in one geographical area. This would also reduce both
time and cost involved in data collection. However, care should be
exercised in dividing the population into various strata. Each stratum
must contain, as far as possible, homogeneous units, as otherwise the
reliability of the results would be lost. In conclusion, stratification is
an effective sampling device to the extent that it creates classes that
are more homogeneous than the total. When this can be done, the
classes are distinguished that differ among themselves in respect of a
stated characteristic.
Stratification may be futile if classes do not differ among themselves.
Thus, there should be homogeneity within classes and heterogeneity
between classes.

(c) Cluster sampling or multistage sampling Under this method, the
random selection is made of primary, intermediate and final (or the
ultimate) units from a given population or stratum. There are several
stages in which the sampling process is carried out. At first, the first
stage units are sampled by some suitable method, such as simple
random sampling. Then, a sample of second stage unit is selected
from each of the selected first stage units, again by some suitable
method which may be same as or different from the method employed
for the first stage units. Further stages may be added as required. The
procedure may be illustrated as follows: Suppose we want to take a
sample of 5,000 households from the State of Haryana. At the first
stage, the state may be divided into a number of districts and a few
districts are selected at random. At the second stage, each district may
be sub-divided into a number of villages and a sample of villages may
be taken at random. At the third stage, a number of households may
be selected from each of the villages selected at second stage. To take
another example supposes in a particular survey, we wish to take a
sample of 10,000 students from a University. We may take colleges at
the first stage, then draw departments at the second stage, and choose
students as the third and last stage.
Merits: Multi-stage sampling introduces flexibility in the sampling
method which is lacking in the other methods. It enables existing
divisions and sub-divisions of the population to be used as units at
various stages, and permits the field work to be concentrated and yet
large area to be covered. Another advantage of this method is that
sub-division into second stage units need be carried out for only those
first stage units which are included in the sample. It is, therefore,
particularly valuable in surveys of under-developed areas where no
frame is generally sufficiently detailed and accurate for subdivision of
the material into reasonably small sampling units. Limitations:
However, a multi-stage sample is in general less accurate than a
sample containing the same number of final stage units which have
been selected by some suitable single stage process.
(d) Systematic sampling Another sampling form, simple in design
and execution, may be employed when the members of population to
be sampled are arranged in order, the order corresponding to

consecutive numbers. The arrangements of names in a telephone
directory or income-tax returns in the income tax department are the
illustrations of such orderings. A sample of suitable size is obtained
by taking every unit say, seventh unit of the population, one of the
first seven units in this ordered arrangement is chosen at random and
the sample is completely by selecting every seventh unit from the rest
of the list. If the first unit selected is the fifth, the researcher will
include in his sample 12th, 19th, 26th, 33rd, etc. We can generalize
the approach as follows: if the requirements of the survey call for the
inclusion of one unit out of every m units in the population, a unit is
chosen at random from the first m units, thereafter, every unit in the
population when arranged in order, is included in the sample.
This mode of selection is called systematic sampling, m is generally
referred to as the sampling ratio, i.e., the ratio of the population size to
the sample size. Symbolically m = N n . where N is the population
size and n is the sample size. While calculating the value of m, we
may get a fractional value. In such cases, it is rounded off to the
nearest digit. Which sampling scheme to select In sampling, one
scheme is said to be more efficient than another when the sample
estimates developed by the scheme tend to cluster more closely
around the population parameter being estimated. An estimator of the
population parameter should possess the following characteristics:
1.1. It should be unbiased: An estimator is unbiased when the
expected (average) value of the sample statistic is equal to the
population parameter being estimated.
2.1. It should be efficient: Efficiency is with respect to sample size
and it means that the sample estimates should be clustered as closely
possible to the population parameter being estimated for a given
sample size. For example, when the population is normally
distributed, both the sample mean and the median are unbiased
estimators of the population mean. However, for any given sample
size, the sample means cluster more closely around the population
mean than do the sample medians. Thus, both mean and the median
are the unbiased estimators of the population mean. However, the
sample mean is the unbiased efficient estimator of the population
mean. In stratified random sampling, where stratification is

meaningful, a stratified random sample will be more efficient than a
simple random sample of the same size. A sampling design is
considered efficient with respect to cost if the sample estimates
cluster more closely around the population parameter being estimated
than they would for any alternative sampling scheme involving
equivalent rupee expenditure. It should be consistent: An estimator is
considered to be consistent if the sample estimates cluster more and
more closely around the population parameter being estimated as the
sample size increases.
Non-Probability Sampling Methods There are three methods of
sampling in this category. These are explained as follows:
1. Convenience sampling In this scheme, a sample is obtained by
selecting ‘convenient’ population elements. For example, a sample
selected from the readily available sources or lists such as telephone
directory or a register of the small scale industrial units, etc. will give
us a convenient sample. In these cases, even if a random approach is
used for identifying the units, the scheme will not be considered as
simple random sampling. For example, if one studies the wage
structure in a close by textile industry by interviewing a few selected
workers, then the scheme adopted here is convenient sampling. The
results obtained by convenience sampling method can hardly be said
to be representative of the population parameters. Therefore, the
results obtained are generally biased and unsatisfactory. However,
convenient sampling approach is generally used for making pilot
studies, particularly for testing a questionnaire and to obtain
preliminary information about the population.
2. Quota sampling In this method of sampling, the basic parameters
which describe the population are identified first. Then the sample is
selected which conform to these parameters. Thus, in a quota sample,
quotas are fixed according to these parameters, and each field
investigator is assigned with quotas of the number of units to be
interviewed. Within the preassigned quotas, the selection of the
sample elements depends on the personal judgement. For example, if
one is studying the consumer preferences for ice creams among
children and college going students and supposes it is fixed to
interview 250 individuals from each category. If the city has five

colleges, one decides to fix up a quota of 50 students to be
interviewed from each college. It entirely depends upon the
interviewer who will constitute this sub-sample of 50 students in a
college— they may be the first 50 students who visit the ice cream
parlour or may be the 50 students who visit the parlour between 4
p.m. and 6 p.m., etc. Quota sampling method has the advantage that
the sample will conform to the selected parameters of the population.
The cost and time involved in getting information from the sample
will be relatively less for a quota sample but there are many
weaknesses too. Some of these are: 1.1. It is difficult to validate the
information gathered on the elementary units,
2.1. It may be difficult to specify the characteristics of the population
and therefore it may be hard to identify it, 3.1. Even when the sample
does conform to the characteristics used in the quotas, the sample may
be distorted on other factors of importance in the study. For example,
interviewing first 50 students or the last 50 students visiting the ice
cream parlour can make a lot of difference particularly about their
purchasing capacity, tastes, etc. This may completely distort the
results. Quota sampling method is generally used in public opinion
studies, election forecast polls, as there is not sufficient time to adopt
a probability sampling scheme.
3. Judgement sampling Judgement sampling method can also be
called as sampling by opinion. In this method, someone who is well
acquainted with the population decides which members (elementary
units) in his or her judgement would constitute a proper cross-section
representing the parameters of relevance to the study. This method of
sampling is generally used in studies involving performance of
personnel. For example, if one is studying the performance of sales
staff in a marketing organisation, the people here are classified into
top grade, medium grade and low grade performers. Having specified
qualities that are important in the study, the expert (possibly here the
Vice-President-sales) indicates the people who, in his or her
knowledge, would be representative of each of the three categories
mentioned earlier. This, of course, is not a scientific method, but in
the absence of better evidence, such a judgement method may have to
be used. Determination of sample size We prefer samples to

complete enumeration because of convenience and reduced cost of
data collection. However, in sampling, there is a likelihood of missing
some useful information about the population. For a high level of
precision, we need to take a larger sample. How large should be the
sample and what should be the level of precision? In specifying a
sample size, care should be taken such that (i) neither so few are
selected so as to render the risk of sampling error intolerably large,
nor (ii) too many units are included, which would raise the cost of the
study to make it inefficient. It is, therefore, necessary to make a trade-
off between (i) increasing sample size, which would reduce the
sampling error but increase the cost, and (ii) decreasing the sample
size, which might increase the sampling error while decreasing the
cost. Therefore, one has to make a compromise between obtaining
data with greater precision and with that of lower cost of data
collection. Several factors need to be considered before determining
the sample size. The first and the foremost is the size of the error that
would be tolerable for the purposes of decision-making. The second
consideration would be the degree of confidence with the results of
the study, i.e., if one wants to be 100 per cent confident of the results,
the entire population must be studied. However, this is generally too
impractical and costly. Therefore, one must accept something less
than 100 per cent confidence. In practice, the confidence limits most
often used are 99 per cent, 95 per cent and 90 per cent. Most
commonly used confidence limit is 95 per cent. This means that there
is a 5 per cent risk that the true population statistic is outside the range
of possible error specified by the confidence interval. This 5 per cent
risk appears to be acceptable in most of the decisions. Thus, for 95 per
cent level of confidence, Z value is 1.96. The Z value can be obtained
from normal probability distribution for a specified level of
confidence. For determining the sample size, we make use of the
following relationship: xσ = standard error of the estimate = σn xσ
can be calculated if we know the upper and lower confidence limits.
Let these limits be Y, then Z x σ = Y Where Z is the value of the
normal variate for a given confidence level.
The procedure has been explained using the illustration given below:

Illustration 11.1. A state cooperative department is performing a
survey to determine the annual salary earned by managers numbering
3000 in the cooperative sector within the state. How large a sample
size it should take in order to estimate the mean annual earnings
within plus and minus 1,000 and at 95 per cent confidence level? The
standard deviation of annual earnings of the entire population is
known to be Rs. 3,000.
Solution. As the desired upper and lower limit is Rs. 1,000, i.e., we
want to estimate the annual earnings within plus and minus Rs. 1,000.
∴ z xσ = 1,000 As the level of confidence is 95 per cent, the Z value is
1.96 ∴ 1.96 xσ = 1,000 x σ = 1‚000 1.96 = 510.20 The standard error
x σ is given by σ/ n where σ is the population standard deviation ∴ σ
n = 510.20 i.e., 3000 n = 510.20 i.e., n = 3000 510.2 = 5.88 This
gives n = 34.57 Therefore, the desired sample size is about 35. 11.6.1.
Sample size for stratified sampling Once the strata have been
established, we are interested in the size of the stratified random
sample. The size will depend upon whether the proportional or
disproportional (optimal) sample is being taken. A proportional
stratified sample is one in which the sample units in a given stratum
are allocated in proportion to the relative size of the stratum. The
following formula is used for calculation of the proportional sample
for each stratum ni = Ni N × n Where ni = number of sample units
from stratum i, N = the total number of units in the population, Ni =
the total number of units in the stratum i, n = sample size desired. The
standard error of mean is xσ = ∑ i=1 k wi2σi2/ni where wi = the
weight of stratum i = Ni/N, σi = the standard deviation of the ith
stratum, k = the total number of strata. In case of disproportionate
stratified sampling, the proportion of units in the sample stratum is
not equal to the proportion of the population. The formula for sample
allocation in this case is ni = wiσin ∑1k
wiσi Thus, the disproportional stratified sample is more desirable if
standard deviation (σi) of each stratum is known. The standard error
of the mean of a disproportionate stratified sample is
xσ = ∑1k(wiσi)2 ∑ni It may be observed that the standard error for
stratified sample is smaller than for simple random sample, i.e., much

smaller samples may be utilized when the population has been
stratified.
Illustration 11.2. In a market area, shops are divided into two
categories, viz., those that have daily turnover of more than Rs. 2000
and those that have daily turnover of less than Rs. 2000 for the study
of estimating the total sales in the area. The total number of shops in
the first stratum are 420 and in the second stratum 180. A sample of
50 was selected, the standard deviation has been found to be 70 for
first stratum and 95 for second stratum. What size of stratified random
sample should be taken under proportional and disproportional
stratified sampling? Solution. Under the proportional stratified
sampling, the sample size is given by n i = Ni N × n and, therefore
n1 = 420 600 × 50 = 35 and n2 = 180 600 × 50 = 15 The standard
error (σx) = ∑wi2σi2 ni = (0.7)2 × (70)2 35 + (0.3)2 × (95)2 15 =
122.75 = 11.079 For disproportionate sampling, the sample size is
given by: n i = wiσin ∑wiσi ∴ n1 = 0.7 × 70 × 50 0.7 × 70 + 0.3 ×
95 = 2450 77.5 = 32.0 and n2 = 0.3 × 95 × 50 0.7 × 70 + 0.3 × 95 =
1425 77.5 = 18.0 The standard error is given by x σ = ∑1k(wiσi)2
∑ni = (0.7 × 70 + 0.3 × 95)2 50 = 120.125 = 10.96.
Cost as a factor in the determination of the sample size Another
consideration in determining the sample size is the cost. Management
may reduce the level of confidence in an attempt to reduce the cost of
sampling. An illustration will clarify how cost of sampling can be
reduced by reducing the sample size.
Illustration 11.3. In a market area there are 600 shops. A researcher
wishes to estimate number of customers visiting these shops per day.
The researcher wants to estimate the sampling error in the number of
customers visiting is no larger than ± 10 with probability of 0.95. The
previous studies indicated that the standard deviation is 85 customers.
If the cost per interview is Rs. 20 (this includes field work,
supervision of interviewers, coding, editing and tabulation of results
and report writing, etc.), calculate the total cost involved.
Researcher is willing to sacrifice some accuracy in order to reduce
cost. If he settles for an estimate with 0.90 probability, how much
reduction in cost can be achieved? Solution. For 95 per cent
confidence levels, Z xσ = Y i.e., 1.96 xσ = 10.0 ∴ x σ = 10 1.96

Now, x σ is given by σ/ n and therefore, the sample size will be
determined by the equation σ n = 10 1.96 Since σ = 85, we have 85
n = 10 1.96 ∴ n = 277.6 Thus, if the sample is taken as 278, the total
cost involved will be 278 × 20 = Rs. 5560. As this cost is considered
to be on the higher side by the researcher and in order to reduce the
cost, the researcher has now settled to 90 per cent confidence level. At
90 per cent confidence level, the sample size can be calculated as
follows: Z xσ = 10 1.65 xσ = 10 1.65 xσ = 10 or xσ = 10 1.65 ∴ σ
n = 10 1.65 i.e., 85 n = 10 1.65 n = 196.7 The cost of survey for
this sample size will be 197 × 20 = Rs. 3940. Thus, we have observed
that by reducing the confidence level from 95 per cent to 90 per cent,
the researcher would reduce the cost from Rs. 5560 to Rs. 3940. The
researcher may not like to reduce the confidence level further and so
further cost reduction may not be desirable.

UNIT 2
Having discussed the various methods available for picking up a
sample from a population, we would naturally be interested in
drawing statistical inferences - making generalizations about the
population on the basis of a sample drawn from it. The
generalizations to be made about the population are usually either by
way of ¾ estimating the unknown population parameters, or ¾
testing appropriate hypotheses stated in relation to population
parameters in the light of sample data These generalizations, together
with the measurement of their reliability, are made in terms of the
relationship between the values of any sample statistic and those of
the corresponding population parameters. Population parameter is any
number computed (or estimated) for the entire population viz.
population mean, population median, population proportion,
population variance and so on. Population parameter is unknown but
fixed, whose value is to be estimated from the sample statistic that is
known but random. Sample Statistic is any numbers computed from
our sample data viz. sample mean, sample median, sample proportion,
sample variance and so on.
It may be appreciated that no single value of the sample statistic is
likely to be equal to the corresponding population parameter. This
owes to the fact that the sample statistic being random, assumes
different values in different samples of the same size drawn from the
same population.
Referring to our earlier discussion on the concept of a random
variable in the lessons onProbability Distributions, it is not difficult to
see that any sample statistics is a random variable and, therefore, has
a probability distribution better known as the Sampling Distribution
of the statistic.
The sampling distribution of a statistic is the probability distribution
of all possible values the statistic may take when computed from
random samples of the same size drawn from a specified population.
Sampling Distribution of a Statistic
In reality, of course we do not have all possible samples and all
possible values of the statistic. We have only one sample and one
value of the statistic. This value is interpreted with respect to all other

outcomes that might have happened, as represented by the sampling
distribution of the statistic. In this lesson, we will refer to the
sampling distributions of only the commonly used sample statistics
like sample mean, sample proportion, sample variance etc., which
have a role in making inferences about the population.
Why We Study Sampling Distributions?
Sample statistics form the basis of all inferences drawn about
populations. Thus, sampling distributions are of great value in
inferential statistics. The sampling distribution of a sample statistic
possess well-defined properties which help lay down rules for making
generalizations about a population on the basis of a single sample
drawn from it. The variations in the value of sample statistic not only
determine the shape of its sampling distribution, but also account for
the element of error in statistical inference. If we know the probability
distribution of the sample statistic, then we can calculate risks (error
due to chance) involved in making generalizations about the
population. With the help of the properties of sampling distribution of
a sample statistic, we can calculate the probability that the sample
statistic assumes a particular value (if it is a discrete random variable)
or has a value in a given interval. This ability to calculate the
probability that the sample statistic lies in a particular interval is the
most important factor in all statistical inferences. We will
demonstrate this by an example.
Suppose we know that 40% of the population of all users of hair oil
prefers our brand to the next competing brand. A "new improved"
version of our brand has been developed and given to a random
sample of 100 users for use. If 55 of these prefer our "new improved"
version to the next competing brand, what should we conclude? For
an answer, we would like to know the probability that the sample
proportion in a sample of size 100 is as large as 55% or higher when
the true population proportion is only 40%, i.e. assuming that the new
version is no better than the old. If this probability is quite large, say
0.5, we might conclude that the high sample proportion viz. 55% is
perhaps because of sampling errors and the new version is not really
superior to the old. On the other hand, if this probability works out to
a very small figure, say 0.001, then rather than concluding that we

have observed a rare event we might conclude that the true population
proportion is higher than 40%, i.e. the new version is actually superior
to the old one as perceived by members of the population. To
calculate this probability, we need to know the probability distribution
of sample proportion i.e. the sampling distribution of the proportion.
SAMPLING DISTRIBUTION OF THE MEAN Suppose we have
a simple random sample of size n, picked up from a population of size
N. We take measurements on each sample member in the
characteristic of our interest and denote the observation as n xxx 12
respectively. The sample mean for this sample is defined as:
n xxx X n +++ =12 If we pick up another sample of size n from the
same population, we might end up with a totally different set of
sample values and so a different sample mean. Therefore, there are
many (perhaps infinite) possible values of the sample mean and the
particular value that we obtain, if we pick up only one sample, is
determined only by chance. In other words, the sample mean is a
random variable. The possible values of this random variable depends
on the possible values of the elements in the random sample from
which sample mean is to be computed. The random sample, in turn,
depends on the distribution of the population from which it is drawn.
As a random variable, X has a probability distribution. This
probability distribution is the sampling distribution of X . The
sampling distribution of X is the probability distribution of all
possible
values the random variable X may take when a sample of size n is
taken from a specified population. To observe the distribution of X
empirically, we have to take many samples of size n and determine
the value of X for each sample. Then, looking at the various observed
values of
X , it might be possible to get an idea of the nature of the distribution.
We will derive the distribution of X in three cases:
(a) Sampling from infinite populations
(b) Sampling with replacement from finite populations
(c) Sampling without replacement from finite populations
Sampling from Infinite Populations

Let us assume we have a population, with mean μ and variance 2 σ,
which is infinitely large. If we take a sample of size n with individual
values n xxx 12 , then Sample Mean ( )
n xxx X n +++ =12 here 1 x representing the first observed values in
the sample, is a random variable since it may take any of the
population values. Similarly 2 x , representing the second observed
value in sample is also a random variable since it may take any of the
population values. In other words, we can say that i x , representing
the ith observed value in the sample is a random
variable.
Now when the population is infinitely large, whatever is the value of
1 x , the distribution of 2x is not affected by it. This is true for any
other pair of random variables as well. In other words; n xxx 12 are
independent random variables and all are picked up from the same
population. So E() ix = μ and Var() ix = σ2 for i =1, 2,3n
Finally, we have x μ
= E( ) X = E ⎟⎠⎞⎜⎝⎛ ++ + n xxx n 12
= E ⎟⎠⎞⎜⎝⎛++⎟⎠⎞⎜⎝⎛+⎟⎠⎞⎜⎝⎛ n xE n xE n x n ......12 [as E(A +
B) = E(A) + E(B)] =() () () 221 1......11 Ex n Ex n Ex n +++ [as E(nA) = n
E(A)]
= n 1 μ +n 1μ +.…..+n 1μ = μ and 2 x σ
= Var(X ) = Var ⎟⎠⎞⎜⎝⎛ ++ + n xxx n ......12
= Var ⎟⎠⎞⎜⎝⎛++⎟⎠⎞⎜⎝⎛+⎟⎠⎞⎜⎝⎛ n xVar n xVar n x n ......12
[as Var(A + B) = Var (A) + Var (B)]
= () 1)......(1()1 22212 n Varx n Varx n Varx n +++ [as Var(nA) = n2 Var(A)]
= 2 2 2 2 2 2 1......11 σσ σ nnn +++ = n2 σ .So, x σ = SD(X ) = n σ
Sampling With Replacement from Finite Populations
The above results have been obtained under the assumption that the
random variables nxxx ,,...... 12 are independent. This assumption is
valid when the population is infinitely large. It is also valid when the
sampling is done with replacement, so that the population is back to
the same form before the next sample member is picked up. Hence, if
the sampling is done with replacement, we would again have: x μ
= E( ) X = μ and 2 x σ
= Var(X ) =n
2 σ or x σ = SD(X ) = n σ
Sampling Without Replacement from Finite Populations

When sampling without replacement from a finite population, the
probability distribution of the second random variable depends on
what has been the outcome of the first pick and so on. In other words,
the n random variables representing the n sample members do not
remain independent, the expression for the variance of X changes.
The results in this case will be:
x μ= E( ) X = μ
and 2 x σ = Var(X ) = 1.2 − −N Nnn σ or x σ = S.D(X ) = 1. − −N
Nnn σ By comparing these expressions with the ones derived above
we find that the variance of X is the same but further multiplied by a
factor 1− −N Nn. This factor is, therefore, known as the finite
population multiplier or the correction factor.
In practice, almost all the samples are picked up without replacement.
Also, most populations are finite although they may be very large and
so the variance of the mean should theoretically be found by using the
expression given above. However, if the population size (N) is large
and consequently the sampling ratio (n/N) small, then the finite
population multiplier is close to 1 and is not used, thus treating large
finite populations as if they were infinitely large. For example, if N =
100,000 and n = 100, the finite population multiplier will be 0.9995,
which is very close to 1 and the variance of the mean would, for all
practical purposes, be the same whether the population is treated as
finite or infinite. As a rule of that, the finite population multiplier may
not be used if the sampling ratio (n/N) is smaller than 0.05.
Above discussion on the sampling distribution of mean, presents two
very important results, which we shall be using very often in
statistical estimation and hypotheses testing. We have seen that the
expected value of the sample mean is the same as the population
mean. Similarly, that the variance of the sample mean is the variance
of the population divided by the sample size (and multiplied by the
correction factor when appropriate). The fact that the sampling
distribution of X has mean μ is very important. It means that, on the
average, the sample mean is equal to the population mean. The
distribution of the statistic is centered on the parameter to be
estimated, and this makes the statistic X a good estimator of μ.

This fact will become clearer in the next lesson, where we will discuss
estimators and their properties. The fact that the standard deviation of
X is n σ means that as the samplesize increases, the standard deviation
of X decreases, making X more likely to be close to μ.
This is another desirable property of a good estimator, If we take a
large number of samples of size n, then the average value of the
sample means tends to be close to the true population mean. On the
other hand, if the sample size is increased then the variance of X gets
reduced and by selecting an appropriately large value of n, the
variance of X can be made as small as desired.
The standard deviation of X is also called the standard error of
the mean. It indicates the extent to which the observed value of
sample mean can be away from the true value, due to sampling errors.
For example, if the standard error of the mean is small, we may be
reasonably confident that whatever sample mean value we have
observed cannot be very far away from the true value.
Before discussing the shape of the sampling distribution of mean, let
us verify the above results empirically, with the help of a simple
example. Consider a discrete uniform population consisting of the
values 1, 2, and 3. If the random variable X represents these
population values, its mean is
μ = N Xi∑ = 3 6 = 2
and variance isσ2 = () N Xi 2∑ − μ =
222 3 2)(32)(22)(1 +−+−− = 3 2
(a) Sampling with Replacement
If random samples of size n = 2 are drawn with replacement from this
population, we will have Nn = 32 = 9 possible samples. These are
shown in Box 12-1 along with the corresponding sample mean values,
which vary from 1 to 3.
The resulting distribution of X is given below:
X : 1 1.5 2 2.5 3
P(X ) : 1/9 2/9 3/9 2/9 1/9
Box 12-1
Sample No. 1 Sample No. 2 Sample No. 3
(1,1) X = 1
(1,2) X = 1.5

(1,3) X = 2
Sample No. 4 (2,1) X = 1.5
Sample No. 5 (2,2) X = 2
Sample No. 6 (2,3) X = 2.5
Sample No. 7 (3,1) X = 2
Sample No. 8 (3,2) X = 2.5
Sample No. 9 (3,3) X = 3
Now we can find out the mean and variance of the sampling
distribution, the necessary
calculations are given in Table 12-1.
Table 12-1 Calculations for x μ
and 2 x σ
X ( ) PX ( ) PXX . ( ) ( )2 .[] EXXXP − 1 1.5 2 2.5 3 1/9 2/9 3/9 2/9
1/9 1/9 3/9 6/9 5/9 3/9 1/9 2/36 0 2/36 1/9 ( ) 1 =∑ PX ( ) .2 =∑ PXX
( ) ( ) /3 ]1.[ 2 −=∑ EXXXP
So the mean of the sampling distribution,
xμ
= E( ) X = ( ) ∑ PX X. = 2 = μ
and the variance of the sampling distribution, 2 x σ = Var(X )
= ( ) ( )2 .[] EXXXP −∑ =1/3 = 2/3 2 =n2 σ
(b) Sampling without Replacement
If random samples of size n = 2 are drawn without replacement from
this population, we will have NPn = 3P2 = 6 possible samples. These
are shown in Box 12-2 along with the corresponding sample mean
values, which vary from 1.5 to 2.5. Box 12-2 Sample No. 1 (1,2) X =
1.5 Sample No. 2 (1,3) X = 2 Sample No. 3 (2,1) X = 1.5 Sample No.
4 (2,3) X = 2.5 Sample No. 5 (3,1) X = 2 Sample No. 6 (3,2) X = 2.5
The resulting distribution of X is given below:
X : 1.5 2 2.5
P (X ) : 2/6 2/6 2/6
Now we can find out the mean and variance of the sampling
distribution, the necessary
calculations are given in Table 12-2.
Calculations for x μ and 2 x σ

X ( ) PX ( ) PXX . ( ) ( )2 .[] EXXXP − 1.5 2 2.5 2/6 2/6 2/6 3/6 4/6
5/6 2/24 0 2/24 ( ) 1 =∑ PX ( ) .2 =∑ PXX ( ) ( ) /6 ]1.[ 2 −=∑
EXXXP
So the mean of the sampling distribution,
x μ = E( ) X = ( ) ∑ PX X. = 2 = μ
and the variance of the sampling distribution, 2 x σ = Var(X )
= ( ) ( )2 .[] EXXXP −∑ = 1/6 = 31 32. 2 /32 − − =1.2 − −N Nnn σ
Now if we compare the shapes of the parent population and the
resulting sampling distribution of mean, we find that although our
parent population is uniformly distributed, the sampling distribution
of mean is symmetrically distributed.
If we increase the sample size n we observe an interesting and
important fact. As n increases ¾ the possible values X can assume
increases, so the number of rectangles increases ¾ the probability that
X assumes a particular value decreases i.e. the width of rectangles
decreases probability Parent Population and Sampling Distribution
of Mean for n = 2 and n = 5 .In the limiting case when the sample
size n increases infinitely, the particular values X can assume
approaches infinity and the probability that X assumes a particular
value approaches to zero. In other words, the limiting distribution of
X is normal distribution.
Thus as n → ∝ X ~ N (μ, 2, 2 n σ) f(X)
Parent Sampling Distribution of Mean Population n
=2 n=5
P(a < X< b) Total Area f (X)
Limiting Distribution of X
THE CENTRAL LIMIT THEOREM The result we just stated - the
limiting distribution of X is the normal distribution - is one of the
most important results in statistics. It is popularly known as the
central limit theorem.
When sampling is done from a population with mean μ and standard
deviation σ, the sampling distribution of the sample mean X tends to a
normal distribution with mean μ and standard deviation n σ as the
sample size n increases.
For "Large Enough" n: X ~ N (μ, 22 n σ)

The central limit theorem is remarkable because it states that the
distribution of the sample mean X tends to a normal distribution
regardless of the distribution of the population from which the
random sample is drawn. The theorem allows us to make probability
statements about the possible range of values the sample mean may
take. It allows us to compute probabilities of how far away X may be
from the population mean it estimates.
Sampling Distributions of X for different Sample Sizes
The central limit theorem says that, in the limit, as n goes to infinity
(n → ∝ ), the distribution of X becomes a normal distribution
(regardless of the distribution of the population). The rate at which the
distribution approaches a normal distribution does depend, however,
on the shape of the distribution of the parent population:
¾ if the population itself is normally distributed, the distribution of
X is normal for any sample size n ¾ if the population distributions are
very different from a normal distribution, a relatively large sample
size is required to achieve a good normal approximation for the
distribution of X
Several parent population distributions and the resulting sampling
distributions of X for different sample sizes.
Since we often do not know the shape of the population
distribution, it would be useful to have some general rule of
thumb telling us when a sample is “Large Enough” that we may
apply the central limit theorem:
In general, a sample of 30 or more elements is considered “Large
Enough” for the central limit theorem to be applicable.
We emphasize that this is a general, and somewhat arbitrary, rule. A
larger minimum sample size may be required for a good normal
approximation when the population distribution is very different from
a normal distribution. By the same reason, a smaller minimum sample
size may suffice for a good normal approximation when the
population distribution is close to a normal distribution.
Population Distribution and the Sampling Distribution of X
should help clarify the distinction between the population distribution
and the sampling distribution of X . The figure emphasizes the three
aspects of the central limit theorem:

1. When the sample size is large enough, the sampling distribution of
X is normal
2. The expected value of X is μ .
3. The standard deviation of X is n σ .
The last statement is the key to the important fact that as the sample
size increases, the variation of X about its mean μ decreases. Stated
another way, as we buy more information (take a larger sample), our
uncertainty (measured by the standard deviation) about the parameter
being estimated decreases.
The History of the Central Limit Theorem
What we call the central limit theorem actually comprises several
theorems developed over the years. The first such theorem was the
discovery of the normal curve by Abraham De Moivre in 1733, when
he discovered the normal distribution as the limit of the binomial
distribution. The fact that the normal distribution appears as a limit of
the binomial distribution as n increases is a form of the central limit
theorem. Around the turn of the twentieth century, Liapunov gave a
more general form of the central limit theorem, and in 1922
Lindeberg gave the final form we use in applied statistics. In 1935, W
Feller gave the proof of the necessary condition of the theorem.
Let us now look at an example of the use of the central limit theorem.
Example
ABC Tool Company makes Laser XR; a special engine used in
speedboats. The company’s engineers believe that the engine delivers
an average power of 220 horsepower, and that the standard deviation
of power delivered is 15 horsepower. A potential buyer intends to
sample 100 engines (each engine to be run a single time). What is the
probability that the sample mean X will be less than 217 horsepower?
Solution: Given that:
Population mean μ = 220 horsepower
Population standard deviation σ = 15 horsepower
Sample size n = 100
Here our random variable X is normal (or at least approximately so,
by the central limit theorem as our sample size is large).
X ~ N (μ, 22 n σ)

or X ~ N (220, 22 15100 ) So we can use the standard normal
variable Z = nX σμ − to find the required probability, P(X < 217) =
P(Z < 15100 217220 −) = P(Z < -2) = 0.0228.
So there is a small probability that the potential buyer’s tests will
result in a sample mean less than 217 horsepower.
SAMPLING DISTRIBUTION OF THE PROPORTION
Let us assume we have a binomial population, with a proportion p of
the population possesses a particular attribute that is of interest to us.
This also implies that a proportion q (=1-p) of the population does not
possess the attribute of interest. If we pick up a sample of size n with
replacement and found x successes in the sample, the sample
proportion of success ( p) is given by p = n x x is a binomial random
variable, the possible value of this random variable depends on the
composition of the random sample from which p is computed. The
probability of x successes in the sample of size n is given by a
binomial probability distribution, viz. P( x) = nCx p x qn-x Since
p = n x and n is fixed (determined before the sampling) the
distribution of the number of successes (x) leads to the distribution of
p.
The sampling distribution of p is the probability distribution of all
possible values the random variable p may take when a sample of size
n is taken from a specified population.
The expected value and the variance of x i.e. number of successes in a
sample of size n is known to be:
E(x) = n p
Var (x) = n p q
Finally we have mean and variance of the sampling distribution
of p
p μ= E( ) p = E ⎟⎠⎞⎜⎝⎛ n x = n 1 E(x) = n 1 .n p = p and 2
p σ = Var ( ) p = Var ⎟⎠⎞⎜⎝⎛ n x = 2 1 n . Var(x) = 2 1 n. n p q
= n pq p σ = SD( ) p = n pq
When sampling is without replacement, we can use the finite
population correction factor, so
sampling distribution of p has its Mean p μ= p Variance 2 p σ = n
pq . ⎟⎠⎞⎜⎝⎛ − − 1N Nn and standard deviation p σ = 1. − −N Nnn
pq

As the sample size n increases, the central limit theorem applies here
as well. The rate at which the distribution approaches a normal
distribution does depend, however, on the shape of the distribution of
the parent population. ¾ if the population is symmetrically
distributed, the distribution of p approaches the normal distribution
relatively fast ¾ if the population distributions are very different from
a symmetrical distribution, a relatively large sample size is required to
achieve a good normal approximation for the distribution of p. In
order to use the normal approximation for the sampling distribution of
p, the sample size needs to be large. A commonly used rule of thumb
says that the normal approximation to the distribution of p may be
used only if both n p and n q are greater than 5. We now state the
central limit theorem when sampling for the population proportion p.
When sampling is done from a population with proportion p, the
sampling
distribution of the sample proportion p approaches to a normal
distribution with proportion p and standard deviation pqn as the
sample size n increases.
For "Large Enough" n: p ~ N (p, 2 pqn )
The estimated standard deviation of pis also called its standard error.
We demonstrate the use of the theorem .A manufacturer of screws has
noticed that on an average 0.02 proportion of screws produced are
defective. A random sample of 400 screws is examined for the
proportion of defective
screws. Find the probability that the proportion of the defective
screws ( p) in the sample is between 0.01 and 0.03?
Population proportion p = 0.02
So q = 0.08 (= 1-0.02)
Sample size n = 400
Since the population is infinite and also the sample size is large, the
central limit theorem applies. So p ~ N (p, 2 pqn )
p ~ N (0.02, 2 )400.08)(0.02(0 )
We can find the required probability using standard normal variable Z
= ⎟⎟⎠⎞⎜⎜⎝⎛ − pqn pp / P(0.01 < p< 0.03) = P
⎟⎟⎟⎟⎞⎜⎜⎜⎜⎝⎛ −<< −400 08)0.02)(0.( .020300.400 08)0.02)(0.(

.020100. Z = P ⎟⎠⎞⎜⎝⎛<< − .0070 .010 .0070 .010 Z = P(-
1.43 < Z < 1.43) = 2 P(0 < Z < 1.43) = 0.8472 So there is a very
high probability that the sample will result in a proportion between
0.01and 0.03.
SAMPLING DISTRIBUTION OF THE DIFFERENCE OF
SAMPLE MEANS In order to bring out the sampling distribution of
the difference of sample means, let us assume we have two
populations labeled as 1 and 2. So that μ1 and μ2 denote the two
population means. σ1 and σ2 denote the two population standard
deviations n1 and n2 denote the two sample sizes 12 and XX denote
the two sample means. Let us consider independent random sampling
from the populations so that the sample sizes need not be same for
both populations.
Since 12 and XX are random variables so is their difference 12 - XX
. As a random variable, 12 - XX has a probability distribution. This
probability distribution is the sampling distribution of 12 - XX. The
sampling distribution of 12 - XX is the probability distribution of all
possible values the random variable 12 - XX may take when
independent samples of size n1 and n2 are taken from two specified
populations.
Mean and Variance of 12 - XX ,12X X− μ
= ( ) 12 - XXE = ( ) ( ) 12 EXEX − = μ1 - μ2 and 2
X12 X− σ = ( ) 12 - XXVar = ( ) ( ) 12 VarXVarX + = 22 21
2 1 nn σσ + ; when sampling is with replacement
= 1 . 1 . 2 22 2 2 2 1 11 1 2 1 N Nn Nn Nn n σσ
; when sampling is without replacement As the sample sizes n1 and
n2 increases, the central limit theorem applies here as well. So westate
the central limit theorem when sampling for the difference of
population means 12 - XX . When sampling is done from two
populations with means μ1 and μ2 and standard deviations σ1 and σ2
respectively, the sampling distribution of the
difference of sample means 12 - XX approaches to a normal
distribution with mean μ1 - μ2 and standard deviation22 212 1 nn σσ
+ as the sample sizes n1 and n2 increases.
For "Large Enough" n1 and n2: 12 - XX ~ N ( μ1 - μ2, 2,2,2 2,1,2
1 nn σσ + )

The estimated standard deviation of 12 - XX is also called its
standard error. We demonstrate the use of the theorem.
Example :The makers of Duracell batteries claims that the size AA
battery lasts on an average of 45 minutes longer than Duracell’s main
competitor, the Energizer. Two independent random
samples of 100 batteries of each kind are selected. Assuming 84 1 = σ
minutes and 672 = σminutes, find the probability that the difference in
the average lives of Duracell and Energizer batteries based on
samples does not exceed 54 minutes.
μ1 - μ2 = 45 σ1 = 84 and σ2 = 67
n 1 =100 and n2 = 100
Let 12 and XX denote the two sample average lives of Duracell and
Energizer batteries respectively. Since the population is infinite and
also the sample sizes are large, the central limit theorem applies.
i.e 12 - XX ~ N ( μ1 - μ2, 2,2,2 212 1 nn σσ + )
12 - XX ~ N (45 , 2,22 100 67 100 84 + )
So we can find the required probability using standard normal
variable ( ) ()22 212 1 1212 nn XX
Zσσμμ+−−− = So P( 12 - XX < 54) = P(Z< 100 67100 84 5445 22 +
−) = P(Z < 0.84) = 1- 0.20045 = 0.79955 So there is a very
high probability that the difference in the average lives of Duracell
and Energizer batteries based on samples does not exceed 54 minutes.
SAMPLING DISTRIBUTION OF THE DIFFERENCE OF
SAMPLE PROPORTIONS
Let us assume we have two binomial populations labeled as 1 and 2.
So that p 1 and p2 denote the two population proportions n1 and n2
denote the two sample sizes 12 and pp denote the two sample
proportions Let us consider independent random sampling from the
populations so that the sample sizes need not be same for both
populations.Since 12 and pp are random variables so is their
difference 12 - pp . As a random variable, 12 - pp has a probability
distribution. This probability distribution is the sampling distribution
of 12 - pp. The sampling distribution of 12 - pp is the probability
distribution of all possible values the random variable 12 - pp may

take when independent samples of size n1 and n2 are taken from two
specified binomial populations.
Mean and Variance of 12 - pp
12 pp − μ
= ( ) 12 - ppE = ( ) ( ) 12 EpEp −
= p1 - p2
and 2 12 pp − σ
= ( ) 12 - ppVar = ( ) ( ) 12 VarpVarp +
=222111n pq n pq + ; when sampling is with replacement
= ⎟⎟⎠⎞⎜⎜⎝⎛ − − +⎟⎟⎠⎞⎜⎜⎝⎛ − − 1 . 1 . 2 22 2 22 1 11 1 11
N Nn n pq N Nn n pq ; when sampling is without replacement As the
sample sizes n1 and n2 increases, the central limit theorem applies
here as well. So we state the central limit theorem when sampling for
the difference of population proportions 12 - pp When sampling is
done from two populations with proportions p1 and p2 respectively,
the sampling distribution of the difference of sample proportions 12 -
pp approaches to a normal distribution with mean p1 - p2 and
standard
Deviation222111n pqn pq + as the sample sizes n1 and n2 increases.
For "Large Enough" n1 and n2: 12 - pp ~ N (p 1 - p2, 2222111n
pqn pq + )
The estimated standard deviation of 12 - pp is also called its standard
error. We demonstrate
the use of the theorem
Example 12
It has been experienced that proportions of defaulters (in tax
payments) belonging to business
class and professional class are 0.20 and 0.15 respectively. The results
of a sample survey
are:
Business class Professional class
Sample size: n1 = 400 n2 = 420
Proportion of defaulters: 0.21 1 =p .14 0 2 =p
Find the probability of drawing two samples with a difference in the
two sample proportions
larger than what is observed.

p1 = 0.20 p2 = 0.15 q1 = 1-0.20 = 0.80 q2 = 1-0.15 = 0.85
n 1 = 400 n2 = 420
0.21 1 =p .14 0 2 =p
Since the population is infinite and also the sample sizes are large, the
central limit theorem applies. i.e. 12 - pp ~ N (p 1 - p2,222111n pqn
pq + ) 12 - pp ~ N (0.05,2420 85)0.15)(0.(400 80)0.20)(0.( + ) So
we can find the required probability using standard normal variable ( )
()2221111212n pqn pq ppppZ + −−− = P( 12 - pp> 0.07) = P(Z >400
85)0.15)(0.(400 80)0.20)(0.( .050700. + −) = P(Z > 0.76) =
0.22363 So there is a low probability of drawing two samples with a
difference in the two sample proportions larger than what is observed.
SMALL SAMPLING DISTRIBUTIONS
Up to now we were discussing the large sampling distributions in the
sense that the various sampling distributions can be well
approximated by a normal distribution for “Large Enough” sample
sizes. In other words, the Z-statistic is used in statistical inference
when sample size is large. It may, however, be appreciated that the
sample size may be prohibited from being large either due to physical
limitations or due to practical difficulties of sampling costs being too
high. Consequently, for our statistical inferences, we may often have
to contend ourselves with a small sample size and limited
information. The consequences of the samplebeing small; n < 30; are
that ¾ the central limit theorem ceases to operate, and ¾ the sample
variance S2 fails to serve as an unbiased estimator of 2 σ Thus, the
basic difference which the sample size makes is that while the
sampling distributions based on large samples are approximately
normal and sample variance S2 is an unbiased estimator of 2 σ, the
same does not occur when the sample is small.
It may be appreciated that the small sampling distributions are also
known as exact sampling distributions, as the statistical inferences
based on them are not subject to approximation. However, the
assumption of population being normal is the basic qualification
underlying the application of small sampling distributions.
In the category of small sampling distributions, the Binomial and
Poisson distributions were already discussed in lesson 9. Now we will

discuss three more important small sampling distributions – the chi-
square, the F and the student t-distribution. The purpose of discussing
these distributions at this stage is limited only to understanding the
variables, which define them and their essential properties. The
application of these distributions will be highlighted in the next two
lessons. The small sampling distributions are defined in terms of the
concept of degrees of freedom.We will discuss this before concept
proceeding further.
Degrees of Freedom (df)
The concept of degrees of freedom (df) is important for many
statistical calculations and probability distributions. We may define df
associated with a sample statistic as the number of observations
contained in a set of sample data which can be freely chosen. It refer
to the number of independent variables which vary freely without
being influenced by the restrictions imposed by the sample statistic(s)
to be computed.
Let n xxx ,...... 12 be n observations comprising a sample whose mean
∑ = = n i ixnx 1 1 is a value
known to us. Obviously, we are free to assign any value to n-1
observation out of nobservations. Once the value are freely assigned
to n-1observations, freedom to do the same for the nth observation is
lost and its value is automatically determined as nth observation =
nx- sum of n-1 observations = nx ∑ − = − 1 1 n I ix
As the value of nth observation must satisfy the restriction nx x n i i
=∑ =1
We say that one degree of freedom, df is lost and the sum nx of n
observations has n-1 df associated with it.
For example, if the sum of four observations is 10, we are free to
assign any value to three observations only, say, 4 and 12, 231 =
==xxx . Given these values, the value of fourth observation is
automatically determined as () 231 4 1 4 xx xxx i i ++=− ∑ = 381 4)
2110(4 + −+=x 3 4 =x
Sampling essentially consists of defining various sample statistics
and to make use them in estimating the corresponding population
parameters. In this respect, degrees of freedom may be defined as the
number of n independent observations contained in a sample less the

number of parameters m to be estimated on the basis of that sample
information, i.e. df = n-m.
For example, when the population variance σ 2 is not known, it is to
be estimated by a particular value of its estimator S2; the sample
variance. The number of observations in the sample being n, df = n-m
= n-1 because σ 2 is the only parameter (i.e. m =1) to be estimated by
the sample variance.
SAMPLING DISTRIBUTION OF THE VARIANCE
We will now discuss the sampling distribution of the variance. We
will first introduce the concept of the sample variance as an unbiased
estimator of population variance and then present the chi-square
distribution, which helps us in working out probabilities for the
sample variance.
THE SAMPLE VARIANCE
By now it is implicitly clear that we use the sample mean to estimate
the population mean and sample proportion to estimate the population
proportion, when those parameters are unknown. Similarly, we use a
sample statistic called the sample variance to estimate the population
variance.
As will see in the next lesson on Statistical Estimation a sample
statistic is an unbiased estimator of the population parameter when the
expected value of sample statistic is equal to the corresponding
population parameter it estimates. Thus, if we use the sample
variance S2 as an unbiased estimator of population variance σ 2.
Then E(S2) = σ 2 However, it can be shown empirically that while
calculating S2 if we divide the sum of square of deviations from mean
(SSD) i.e. ( ) ∑ = − n i xx 1 2 by n, it will not be an unbiased
estimator of σ 2 and I−∑ = n xxEni 12.
= 21 σn n− = n 2 2 σ σ − i.e. () n xx∑ − 2 will underestimate the
population variance σ 2 by the factor n 2 σ. To compensate for this
downward bias we divide ( ) ∑ = − n i xx 1 2 by n-1, so that () 1122 −
−= ∑=n xxSni is an unbiased estimator of population variance σ 2 and
we have:
−∑ = 1 1 2n xxEni = σ 2.
In other words to get the unbiased estimator of population variance σ
2, we divide the sum () ∑ = − n i xx 1 2 by the degree of freedom n-1.

THE CHI-SQUARE DISTRIBUTION
Let X be a random variable representing N values of a population,
which is normally distributed with mean μ and variance σ 2, i. e. X =
{} NXXX ,...... 12.
We may draw a random sample of size n comprising n xxx ,...... 12
values from this population.
As brought out in section 12.2, each of the n sample values n xxx ,......
12 can be treated as an
independent normal random variable with mean μ and variance σ 2.
In other words i x ~ N ( μ, σ 2) where i = 1, 2, ………n . Thus
each of these n normally distribution random variable may be
standardized so that σ μ −= ii x Z ~ N (0, 12) where i = 1, 2,
………n.
A sample statistic U may, then, be defined as 22 22 1 ......... n ZZUZ
++=+ ∑==ni iUZ 1 2 ∑
= n i ixU 12σ μ Which will take different values in repeated random
sampling. Obviously, U is a random variable. It is called chi-square
variable, denoted by χ2. Thus the chi-square random variable is the
sum of several independent, squared standard normal random
variables.
The chi-square distribution is the probability distribution of chi-
square variable. So the chi-square distribution is the probability
distribution of the sum of several independent, squared standard
normal random variables. The chi-square distribution is defined as 2
1222 1 2 ()() 2 χχ χ χ Cedf n −− = for χ2 ≥ 0 ,where e is the base of
natural logarithm, n denotes the sample size (or the number of
independent normal random variables).C is a constant to be so
determined that the total area under the χ2 distribution is unity. χ2
values are determined in terms of degrees of freedom, df = n
Properties of χ2 Distribution 1. A χ2 distribution is completely
defined by the number of degrees of freedom, df = n. So there are
many χ2 distributions each with its own df. 2. χ2 is a sample statistic
having no corresponding parameter, which makes χ2distribution a
non-parametric distribution. 3. As a sum of squares the χ2 random
variable cannot be negative and is, therefore, bounded on the left by
zero.

2 Distribution with Different Numbers of df 4. The mean of a χ2
distribution is equal to the degrees of freedom df. The variance of the
distribution is equal to twice the number of degrees of freedom df
.E(χ2) = n Var (χ2 ) = 2n 5. Unless the df is large, a χ2 distribution
is skewed to the right. As df increases, the χ2 distribution looks more
and more like a normal. Thus for large df χ2 ~ N (n, 2 2n ) It
shows several χ2 distributions with different numbers of df. In
general, for n ≥ 30, the probability of χ2 taking a value greater than or
less than a particular value can be approximated by using the normal
area tables.
If 22 3 2 2 2 1 ,,......... , k χχ χχ
are k independent χ2 random variables, with degrees of freedom k
nnnn ,,........., 231 . Then their sum 22 3 2 2 2 1 ......... k χχ χχ ++++
also possesses a χ2 distribution with df = k nnnn ++++ .........231 .
12.8.3 The χ2Distribution in terms of Sample Variance S2 Now, we
know that the LHS of the above equation is a random variable which
has chi-square distribution, with df = n .We also know that if x ~ N
(μ, 2,2 n σ) Then 2 −nx σμ will have a chi-square
distribution with df = 1 .
Since the two terms on the RHS are independent, ( ) 2 21 σ nS − will
also has a chi-square distribution with df = n-1. One degree of
freedom is lost because all the deviations are measured from x and not
from μ .. Expected Value and Variance of S2 .In practice, therefore,
we work with the distribution of ( ) 2 21 σ nS − and not with the
distribution of S2 directly.
Since () 2 21 σ nS − has a chi-square distribution with df = n-1.So E
() 1 1 2 2 − nnS σ )1 (1 22 =−− SnEn σ 22 () σ =ES Also
Var 1) 2(1)( 2 2 =−− nnS σ Using the definition of variance, we get E
() 1) 2(1)1( 2 2 2 2 2 − − − n nSEnS σσ.
or E () 1)2(1)(1 2 2 2 ⎡ nnnS σ or E () () 1) 2(11)2(1)(1 2 2 2 2
4 42 =− n nSnnnS σσ or 1)2(21 22244 4 2 =− Sn ESn σσ σ or () 1)
2(()1 222 4 2 =−− − Sn En σ σ or 4 2 222 1)( 1)2(() σσ − − −= n
nES.
So 1 2() 4 2 − = n VarS σ It may be noted that the conditions
necessary for the central limit theorem to be operative in the case of
sample variance S2 are quite restrictive. For the sampling distribution

of S2 to be approximately normal requires not only that the parent
population is normal, but also that the sample is at least as large as 100.
Example 12
In an automated process, a machine fills cans of coffee. The variance of
the filling process is known to be 30. In order to keep the process in
control, from time to time regular checks of the variance of the filling
process are made. This is done by randomly sampling filled cans, easuring
their amounts and computing the sample variance. A random sample of
101 cans is selected for the purpose. What is the probability that the
sample variance is between 21.28 and 38.72?
Solution: We have
Population variance σ 2 = 30
n = 101
We can find the required probability by using the chi-square distribution
χ2 = () 2 21 σ nS −
So P(21.28 < S2 < 38.72) = − << − 30 .72)381011( 30 .28)211011( 2
χP
= P(70.93 < χ2 < 129.06) = P(χ2 > 70.93) - P(χ2 > 129.06) ≈ 0.990
– 0.025 = 0.965
Since our population is normal and also sample size is quite large, we can
also estimate the
required probability using normal distribution.
We have S2 ~ ( σ 2, 2,4 12 −n σ)
So P(21.28 < S2 < 38.72) = 1
2 .723812 .28214242nZnPσ σσσ 388= 1011 30302 723038.1011 30302
283021.
XxZxx P = ⎛<< − .364 .728 .364 .728 PZ = () 22 <<− PZ = () 022 << PZ
= .4772 20 x
= 0.9544 Which is approximately the same as calculated above using
χ2distribution.
THE F -DISTRIBUTION Let us assume two normal population with
variances 2 1 σ and 2 2 σ repetitively. For a random sample of size n1
drawn from the first population, we have the chi-square variable
() 2 1 2 112 1 1 σ χ nS − = which process a χ2 distribution with ν1 = n1 -1
df Similarly, for a random sample of size n2 drawn from the second
population, we have the chi square variable
() 2 2 2 222 2 1 σ χ nS − = which process a χ2 distribution with ν2 = n2 -1
df A new sample statistic defined as 22 2 1 2 1v vF χ χ = is a random

variable known as F statistic, named in honor of the English statistician Sir
Ronald A Fisher.
Being a random variable it has a probability distribution, which is known
as F distribution. The F distribution is the distribution of the ratio of two
chi-square random variables that are independent of each other, each of
which is divided by its own degrees of freedom.
Properties of F- Distribution
1. The F distribution is defined by two kinds of degrees of freedom – the
degrees of freedom of the numerator always listed as the first item in the
parentheses and the degrees of freedom of the denominator always listed
as the second item in the parentheses. So there are a large number of F
distributions for each pair of v1 and v2. Figure 12-7 shows several F
distributions with different v1 and v2.
2. As a ratio of two squared quantities, the F random variable cannot be
negative and is, therefore, bounded on the left by zero.
F- Distribution with different v1 and v2
3. The ,) ( 12 vvF has no mean for v2 ≤ 2 and no variance for v2 ≤ 4.
However, for v2
>2, the mean and for v2 > 4, the variance is given as
E( ,) ( 12 vv F) = 22 2 −v v Var( ,) ( 12 vv F) =
4))((2 2)2( 2 2 12 12 2 2 −− +− vvv vvv
4. Unless the v2 is large, a F distribution is skewed to the right. As v2
increases, the F distribution looks more and more like a normal. In general,
for v2 ≥ 30, the probability of F taking a value greater than or less than a
particular value can be approximated by using the normal area tables.
5. The F distributions defined as ,) ( 12 vvF and as ,) ( 21 vvF are
reciprocal of each other.
i.e. ,) ( 12 vvF = ,)( 21 1 vvF
THE t-DISTRIBUTION Let us assume a normal population with mean μ
and variance 2 σ
. If xi represent the n values of a sample drawn from this population. Then
σ μ −= ii x Z ~ N (0, 12) where i = 1, 2, ………n
and ()22112 σσ μ ∑ ∑ = = − =⎟⎠⎞⎜⎝⎛ −= n i in i i xx x U ~ χ2 (n-1 df)
where i = 1, 2, ………n
A new sample statistic T may, then, be defined as 22111σσ μ ∑= − −
−=niiixxnx T() 1 21 − − −= ∑=n xxxTni .This statistic - the ratio of the
standard normal variable Z to the square root of the χ2

variable divided by its degree of freedom - is known as ‘t’ statistic or
student ‘t’ statistic, named after the pen name of Sir W S Gosset, who
discovered the distribution of the quantity.
The random variable
Sxiμ − follows t-distribution with n-1 degrees of freedom.
Sxiμ − ~ t (n-1 df) where i = 1, 2, ………n
The t-distribution in terms of Sampling Distribution of Sample Mean
We know X ~ N (μ, 22 n σ) So NX σμ − ~ N (0, 2 1 )
Putting n X σμ − for σ μ −ix in ()2211σσ μ ∑= = n I I I x x n x T , we
get 2 2111σσμ ∑=n i1nn xxWhen defined as above, T again follows t-
distribution with n-1 degrees of freedom.
NS Xμ − ~ t (n-1 df) where i = 1, 2, ………n
Properties of t- Distribution
1. The t-distribution like Z distribution, is unimodal, symmetric about
mean 0, and the t- variable varies from ∝ and ∝.
2. The t-distribution is defined by the degrees of freedom v = n-1, the df
associated with the distribution are the df associated with the sample
standard deviation.
3. The t-distribution has no mean for n = 2 i.e. for v = 1 and no variance
for n ≤ 3 i.e. for v ≤ 2. However, for v >1, the mean and for v > 2, the
variance is given as E(T) = 0 Var(T) =2−v v
t-Distribution with different df
1. The variance 2−v v of the t-distribution must always be greater than 1,
so it is more variable as against Z distribution which has variance 1. This
follows from the fact what while Z values vary from sample to sample
owing to the change in the X alone, the variation in T values are due to
changes in both X and S.
2. The variance of t-distribution approaches 1 as the sample size n tends to
increase. In general, for n ≥ 30, the variance of t-distribution is
approximately the same as that of Z distribution. In other words the t-
distribution is approximately normal for n ≥ 30.

UNIT 3
Statistical methods of measures of central tendency, dispersion,
skewness and kurtosis are helpful for the purpose of comparison and
analysis of distributions involving only one variable i.e. univariate
distributions. However, describing the relationship between two or
more variables, is another important part of statistics.
In many business research situations, the key to decision making lies
in understanding therelationships between two or more variables. For
example, in an effort to predict the behavior of the bond market, a
broker might find it useful to know whether the interest rate of bonds
is related to the prime interest rate. While studying the effect of
advertising on sales, an account executive may find it useful to know
whether there is a strong relationship between advertising dollars and
sales dollars for a company.
The statistical methods of Correlation (discussed in the present
lesson) and Regression (to be discussed in the next lesson) are helpful
in knowing the relationship between two or more variables which
may be related in same way, like interest rate of bonds and prime
interest rate; advertising expenditure and sales; income and
consumption; crop-yield and fertilizer used; height and weights and so
on.
In all these cases involving two or more variables, we may be
interested in seeing:
¾ if there is any association between the variables; ¾ if there is an
association, is it strong enough to be useful; ¾ if so, what form the
relationship between the two variables takes; ¾ how we can make
use of that relationship for predictive purposes, that is, forecasting;
and ¾ how good such predictions will be.
Since these issues are inter related, correlation and regression
analysis, as two sides of a single process, consists of methods of
examining the relationship between two or more variables. If two (or
more) variables are correlated, we can use information about one (or
more) variable(s) to predict the value of the other variable(s), and can
measure the error of estimations - a job of regression analysis.
WHAT IS CORRELATION?

Correlation is a measure of association between two or more
variables. When two or more variables very in sympathy so that
movement in one tends to be accompanied by corresponding
movements in the other variable(s), they are said to be correlated.
“The correlation between variables is a measure of the nature and
degree of association between the variables”.
As a measure of the degree of relatedness of two variables, correlation
is widely used in exploratory research when the objective is to locate
variables that might be related in some way to the variable of interest.
TYPES OF CORRELATION
Correlation can be classified in several ways. The important ways of
classifying correlation
are:
(i) Positive and negative,
(ii) Linear and non-linear (curvilinear) and
(iii) Simple, partial and multiple.
Positive and Negative Correlation If both the variables move in the
same direction, we say that there is a positive correlation, i.e., if one
variable increases, the other variable also increases on an average or if
one variable decreases, the other variable also decreases on an
average.
On the other hand, if the variables are varying in opposite direction,
we say that it is a case of
negative correlation; e.g., movements of demand and supply.
Linear and Non-linear (Curvilinear) Correlation If the change in
one variable is accompanied by change in another variable in a
constant ratio, it is a case of linear correlation. Observe the following
data:
X : 10 20 30 40 50 Y : 25 50 75 100 125
The ratio of change in the above example is the same. It is, thus, a
case of linear correlation.
If we plot these variables on graph paper, all the points will fall on the
same straight line. On the other hand, if the amount of change in one
variable does not follow a constant ratio with the change in another
variable, it is a case of non-linear or curvilinear correlation. If a

couple of figures in either series X or series Y are changed, it would
give a non-linear correlation.
Simple, Partial and Multiple Correlation: The distinction amongst
these three types of correlation depends upon the number of variables
involved in a study. If only two variables are involved in a study, then
the correlation is said to be simple correlation. When three or more
variables are involved in a study, then it is a problem of either partial
or multiple correlation. In multiple correlation, three or more
variables are studied simultaneously. But in partial correlation we
consider onlytwo variables influencing each other while the effect of
other variable(s) is held constant. Suppose we have a problem
comprising three variables X, Y and Z. X is the number of hours
studied, Y is I.Q. and Z is the number of marks obtained in the
examination. In a multiple
correlation, we will study the relationship between the marks obtained
(Z) and the two variables, number of hours studied (X) and I.Q. (Y).
In contrast, when we study the relationship between X and Z, keeping
an average I.Q. (Y) as constant, it is said to be a study involving
partial correlation.
In this lesson, we will study linear correlation between two variables.
CORRELATION DOES NOT NECESSARILY MEAN
CAUSATION The correlation analysis, in discovering the nature and
degree of relationship between variables, does not necessarily imply
any cause and effect relationship between the variables. Two
variables may be related to each other but this does not mean that one
variable causes the other. For example, we may find that logical
reasoning and creativity are correlated, but that does not mean if we
could increase peoples’ logical reasoning ability, we would produce
greater creativity. We need to conduct an actual experiment to
unequivocally demonstrate a causal relationship. But if it is true that
influencing someones’ logical reasoning ability does influence their
creativity, then the two variables must be correlated with each other.
In other words, causation always implies correlation, however
converse is not true. Let us see some situations-

1. The correlation may be due to chance particularly when the data
pertain to a small sample. A small sample bivariate series may show
the relationship but such a relationship may not exist in the universe.
2. It is possible that both the variables are influenced by one or more
other variables.For example, expenditure on food and entertainment
for a given number of households show a positive relationship
because both have increased over time.
But, this is due to rise in family incomes over the same period. In
other words, the two variables have been influenced by another
variable - increase in family incomes.
3. There may be another situation where both the variables may be
influencing each other so that we cannot say which is the cause and
which is the effect. For example, take the case of price and demand.
The rise in price of a commodity may lead to a decline in the demand
for it. Here, price is the cause and the demand is the effect. In yet
another situation, an increase in demand may lead to a rise in price.
Here, the demand is the cause while price is the effect, which is just
the reverse of the earlier situation. In such situations, it is difficult to
identify which variable is causing the effect on which variable, as
both are influencing each other.
The foregoing discussion clearly shows that correlation does not
indicate any causation or functional relationship. Correlation
coefficient is merely a mathematical relationship and this has nothing
to do with cause and effect relation. It only reveals co-variation
between two variables. Even when there is no cause-and-effect
relationship in bivariate series and one interprets the relationship as
causal, such a correlation is called spurious or non-sense correlation.
Obviously, this will be misleading. As such, one has to be very
careful in correlation exercises and look into other relevant factors
before concluding a cause-and-effect relationship.
CORRELATION ANALYSIS
Correlation Analysis is a statistical technique used to indicate the
nature and degree ofrelationship existing between one variable and
the other(s). It is also used along with regression analysis to measure
how well the regression line explains the variations of the dependent
variable with the independent variable.

The commonly used methods for studying linear relationship between
two variables involve both graphic and algebraic methods. Some of
the widely used methods include:
1. Scatter Diagram
2. Correlation Graph
3. Pearson’s Coefficient of Correlation
4. Spearman’s Rank Correlation
5. Concurrent Deviation Method
SCATTER DIAGRAM This method is also known as Dotogram or
Dot diagram. Scatter diagram is one of the simplest methods of
diagrammatic representation of a bivariate distribution. Under this
method, both the variables are plotted on the graph paper by putting
dots. The diagram so obtained is called "Scatter Diagram". By
studying diagram, we can have rough idea about the nature and
degree of relationship between two variables. The term scatter refers
to the spreading of dots on the graph. We should keep the following
points in mind while interpreting correlation:
¾ if the plotted points are very close to each other, it indicates high
degree ofcorrelation. If the plotted points are away from each other, it
indicates low degree of correlation.
Scatter Diagrams
¾ if the points on the diagram reveal any trend (either upward or
downward), the variables are said to be correlated and if no trend is
revealed, the variables are uncorrelated.
¾ if there is an upward trend rising from lower left hand corner and
going upward to the upper right hand corner, the correlation is
positive since this reveals that the values of the two variables move in
the same direction. If, on the other hand, the points depict a
downward trend from the upper left hand corner to the lower right
hand corner, the correlation is negative since in this case the values of
the two variables move in the opposite directions.
¾ in particular, if all the points lie on a straight line starting from the
left bottom and going up towards the right top, the correlation is
perfect and positive, and if all the points like on a straight line starting
from left top and coming down to right bottom, the correlation is
perfect and negative.

The various diagrams of the scattered data in depict different forms of
correlation.
Example
Given the following data on sales (in thousand units) and expenses (in
thousand rupees) of a
firm for 10 month:
Month : J F M A M J J A S O Sales: 50 50 55 60 62 65 68 60
60 50 Expenses: 11 13 14 16 16 15 15 14 13 13 a) Make a Scatter
Diagram.
b) Do you think that there is a correlation between sales and expenses
of the
firm? Is it positive or negative? Is it high or low?
Solution:(a) The Scatter Diagram of the given data is shown
0 5 1015 200 20 40 60 80 SalesExpenses
Scatter Diagram (b) shows that the plotted points are close to each
other and reveal an upward
trend. So there is a high degree of positive correlation between sales
and expenses of the firm.
CORRELATION GRAPH This method, also known as
Correlogram is very simple. The data pertaining to two series are
plotted on a graph sheet. We can find out the correlation by
examining the direction and closeness of two curves. If both the
curves drawn on the graph are moving in the same direction, it is a
case of positive correlation. On the other hand, if both the curves are
moving
in opposite direction, correlation is said to be negative. If the graph
does not show any definite pattern on account of erratic fluctuations
in the curves, then it shows an absence of correlation.
Example 4 Find out graphically, if there is any correlation between
price yield per plot (qtls); denoted by Y and quantity of fertilizer used
(kg); denote by X.
Plot No.: 1 2 3 4 5 6 7 8 9 10 Y: 3.5 4.3 5.2 5.8 6.4 7.3 7.2
7.5 7.8 8.3 X: 6 8 9 12 10 15 17 20 18 24
Solution: The Correlo-gram of the given data is shown
0 5 10 15 20 25 301 2 3 4 5 6 7 8 9 10 Plot Number

X and Y Correlation Graph shows that the two curves move in the
same direction and, moreover, they are very close to each other,
suggesting a close relationship between price yield per plot (qtls) and
quantity of fertilizer used (kg).
Remark: Both the Graphic methods - scatter diagram and correlation
graph provide a ‘feel for’ of the data – by providing visual
representation of the association between the variables. These are
readily comprehensible and enable us to form a fairly good, though
rough idea of the nature and degree of the relationship between the
two variables. However, these methods are unable to quantify the
relationship between them. To quantify the extent of correlation, we
make use of algebraic methods - which calculate correlation
coefficient.
PEARSON’S COEFFICIENT OF CORRELATION A
mathematical method for measuring the intensity or the magnitude of
linear relationship between two variables was suggested by Karl
Pearson (1867-1936), a great British Biometrician and Statistician
and, it is by far the most widely used method in practice.
Karl Pearson’s measure, known as Pearsonian correlation coefficient
between two variables X and Y, usually denoted by r(X,Y) or rxy or
simply r is a numerical measure of linear relationship between them
and is defined as the ratio of the covariance between X and Y, to the
product of the standard deviations of X and Y.
Symbolically xy xy SS XYCovr . ,)(= …………(4.1)
when, ,) ..........(,);........);((, 2211 nn XYXYXY are N pairs of
observations of the variables X and
Y in a bivariate distribution, N YYXX XYCov ∑ −− = )()( ,)(
…………(4.2a)
N XX Sx ∑ − = 2() …………(4.2b) and
N YY Sy ∑ − = 2() …………(4.2c).Thus by substituting Eqs. (4.2)
in Eq. (4.1), we can write the Pearsonian correlation coefficient as
∑∑ ∑ =22 ()1()1 )()(1 YY N XX N YYXX Nr xy
∑∑ ∑ −− −−=22 ()() )()( YYXX YYXX rxy …………(4.3)
If we denote, YY XddX xy =− =− and Then ∑∑=22 xy xyxydd
dd r …………(4.3a) We can further simply the calculations of

Eqs. (4.2) We have ∑ −−= )()(1,)( YYXX N XYCov XY XY N ∑
=− 1
N YN XXY
N∑∑∑ =− 1 [] ∑∑∑=− XYNXY N2 1 …………(4.4) and ∑ =−
22 ()1 XX N Sx 22 ()1 XX N∑ =−
2 =− ∑ ∑ NX X N () [] ∑∑=− 22 2 1 XX N N …………(4.5a)
Similarly, we have () [] ∑∑=− 22 2 2 1 YY N N Sy …………(4.5b)
So Pearsonian correlation coefficient may be found as [] () []() []
∑∑∑∑ ∑ ∑ ∑ −− − = 22 2 22 2 2 11 1 YYN N XXN N XYNXY Nr
xy
or () () ∑∑∑∑ ∑∑ ∑ −− − = 2222 YYXNNX XYNXY rxy
…………(4.6)
Remark: Eq. (4.3) or Eq. (4.3a) is quite convenient to apply if the
means X and Y come out to be integers. If X or/and Y is (are)
fractional then the Eq. (4.3) or Eq. (4.3a) is quite cumbersome to
apply, since the computations of ∑ − 2 () XX , ∑ − 2 () YY and ∑ −−
)()( YYXX are quite time consuming and tedious. In such a case Eq.
(4.6) may be used provided the values of X or/ and Y are small. But if
X and Y assume large values, the calculation of ∑ 2 X ,∑ 2 Y and
∑XY is again quite time consuming.
Thus if (i) X and Y are fractional and (ii) X and Y assume large
values, the Eq. (4.3) and Eq.
(4.6) are not generally used for numerical problems. In such cases, the
step deviation method
where we take the deviations of the variables X and Y from any
arbitrary points is used. We
will discuss this method in the properties of correlation coefficient.
Properties of Pearsonian Correlation Coefficient
The following are important properties of Pearsonian correlation
coefficient:
Pearsonian correlation coefficient cannot exceed 1 numerically. In
other words it lies between –1 and +1. Symbolically, -1 ≤ r ≤1
Remarks: (i) This property provides us a check on our calculations. If
in any problem, the obtained value of r lies outside the limits + 1,
this implies that there is some mistake in our calculations.

(ii) The sign of r indicate the nature of the correlation. Positive value
of r indicates positive correlation, whereas negative value indicates
negative correlation. r = 0 indicate absence of correlation.
(iii) The following table sums up the degrees of correlation
corresponding to various values of r:
Value of r Degree of correlation ±1 perfect correlation ±0.90 or more
very high degree of correlation ±0.75 to ±0.90 sufficiently high
degree of correlation ±0.60 to ±0.75 moderate degree of correlation
±0.30 to ±0.60 only the possibility of a correlation less than ±0.30
possibly no correlation 0 absence of correlation
2. Pearsonian Correlation coefficient is independent of the change of
origin and scale. Mathematically, if given variables X and Y are
transformed to new variables U and V by change of origin and scale,
i. e. U = k YBV h XA − = .Where A, B, h and k are constants and h
> 0, k > 0; then the correlation coefficient between X and Y is same
as the correlation coefficient between U and V i.e., r(X,Y) = r(U, V)
=> rxy = ruv
Remark: This is one of the very important properties of the correlation
coefficient and is extremely helpful in numerical computation of r.
We had already stated that Eq. (4.3) and Eq.(4.6) become quite
tedious to use in numerical problems if X and/or Y are in fractions or
if X and Y are large. In such cases we can conveniently change the
origin and scale (if possible) in X or/and Y to get new variables U and
V and compute the correlation between U and V by the Eq. (4.7)
() () ∑∑∑ ∑∑ ∑ −− − == 2222 VVUNNU UVNUV rr xyuv
…………(4.7)
3. Two independent variables are uncorrelated but the converse is not
true .If X and Y are independent variables then rxy = 0
However, the converse of the theorem is not true i.e., uncorrelated
variables need not necessarily be independent. As an illustration
consider the following bivariate distribution.
X : 1 2 3 -3 -2 -1 Y : 1 4 9 9 4 1
For this distribution, value of r will be 0.
Hence in the above example the variable X and Y are uncorrelated.
But if we examine the data carefully we find that X and Y are not
independent but are connected by the relation Y = X2. The above

example illustrates that uncorrelated variables need not be
independent.
Remarks: One should not be confused with the words uncorrelation
and independence. rxy = 0 i.e., uncorrelation between the variables X
and Y simply implies the absence of any linear (straight line)
relationship between them. They may, however, be related in some
other form other than straight line e.g., quadratic (as we have seen in
the above example), logarithmic or trigonometric form.
4. Pearsonian coefficient of correlation is the geometric mean of the
two regression coefficients, i.e. rxy = xyyx bb .± The signs of
both the regression coefficients are the same, and so the value of r
will also have the same sign. This property will be dealt with in detail
in the next lesson on Regression Analysis.
5. The square of Pearsonian correlation coefficient is known as the
coefficient of determination.
Coefficient of determination, which measures the percentage variation
in the dependent variable that is accounted for by the independent
variable, is a much better and useful measure for interpreting the
value of r. This property will also be dealt with in detail in the next
lesson.
Probable Error of Correlation Coefficient
The correlation coefficient establishes the relationship of the two
variables. After ascertaining this level of relationship, we may be
interested to find the extent upto which this coefficient is dependable.
Probable error of the correlation coefficient is such a measure of
testing the reliability of the observed value of the correlation
coefficient, when we consider it as satisfying the conditions of the
random sampling.
If r is the observed value of the correlation coefficient in a sample of
N pairs of observations for the two variables under consideration, then
the Probable Error, denoted by PE (r) is expressed as ()6745 0.()
SErPEr = or N rPEr 2 1.6745)0( − = There are two main functions
of probable error:
1. Determination of limits: The limits of population correlation
coefficient are r ± PE(r), implying that if we take another random
sample of the size N from the same population, then the observed

value of the correlation coefficient in the second sample can be
expected to lie within the limits given above, with 0.5 probability.
When sample size N is small, the concept or value of PE may lead to
wrong conclusions. Hence to use the concept of PE effectively,
sample size N it should be fairly large.
2. Interpretation of 'r': The interpretation of 'r' based on PE is as
under:
¾ If r < PE(r), there is no evidence of correlation, i.e. a case of
insignificant correlation.
¾ If r > 6 PE(r), correlation is significant. If r < 6 PE(r), it is
insignificant. ¾ If the probable error is small, correlation exist where r
> 0.5
Example Find the Pearsonian correlation coefficient between sales
(in thousand units) and expenses (in thousand rupees) of the following
10 firms:
Firm: 1 2 3 4 5 6 7 8 9 10 Sales: 50 50 55 60 65 65 65 60 60 50
Expenses: 11 13 14 16 16 15 15 14 13 13
Solution: Let sales of a firm be denoted by X and expenses be
denoted by Y
Calculations for Coefficient of Correlation {Using Eq. (4.3) or (4.3a)}
Firm X Y X dX x=− Y dY y=− 2 xd 2 yd xy dd . 1 2 3 4 5 6 7 8 9 10
50 50 55 60 65 65 65 60 60 50 11 13 14 16 16 15 15 14 13 13 -8 -8 -3
2 7 7 7 2 2 -8 -3 -1 0 2 2 1 1 0 -1 -1 64 64 9 4 49 49 49 4 4 64 9 1 0 4
4 1 1 0 1 1 24 8 0 4 14 7 7 0 -2 8 ∑X ∑Y 2 xd∑ 2 yd∑ ∑ xy dd 112=
580= 140 =360 =22 =70 X = N X∑ = 10 580 = 58 and Y = N Y∑
= 10 140= 14 Applying the Eq. (4.3a), we have, Pearsonian
coefficient of correlation ∑∑=22 xy xyxydd dd r 36022 70 x rxy =
7920 70=xy r .78 0=xy r The value of .78 0=xy r , indicate a high
degree of positive correlation between sales and expenses.
Example The data on price and quantity purchased relating to a
commodity for 5 months is given below:
Month : January February March April May Prices(Rs): 10
10 11 12 12 Quantity(Kg): 5 6 4 3 3
Find the Pearsonian correlation coefficient between prices and
quantity and comment on its sign and magnitude.

Solution: Let price of the commodity be denoted by X and quantity
be denoted by Y
Calculations for Coefficient of Correlation {Using Eq. (4.6)} Month
X Y X2 Y 2 XY 1 10 5 100 25 50 2 10 6 100 36 60 3 11 4 121 16 44
4 12 3 144 9 36 5 12 3 144 9 36 113
∑X =55 ∑Y =21 ∑ =609 2X ∑ =95 2Y ∑ = 226 XY Applying the
Eq. (4.6), we have, Pearsonian coefficient of correlation () () ∑∑∑∑
∑ ∑ ∑ −− − = 2222 YYXNNX XYNXY rxy
21)9521)(555555609( 55215226 xxxx xxr xy −− − = 034 11301155
x rxy − = 680 25−=xyr
.98 0=−xyr The negative sign of r indicate negative correlation and
its large magnitude indicate a very high degree of correlation. So
there is a high degree of negative correlation between prices
and quantity demanded.
Example 4-5 Find the Pearsonian correlation coefficient from the
following series of marks obtained by 10 students in a class test in
mathematics (X) and in Statistics (Y):
X : 45 70 65 30 90 40 50 75 85 60 Y : 35 90 70 40 95 40 60 80 80 50
Also calculate the Probable Error.
Solution:
Calculations for Coefficient of Correlation {Using Eq. (4.7)} X Y U
V U2 V 2 UV 45 35 -3 -6 9 36 18 70 90 2 5 4 25 10 65 70 1 1 1 1 1
114
30 40 -6 -5 36 25 30 90 95 6 6 36 36 36 40 40 -4 -5 16 25 20 50 60 -2
-1 4 1 2 75 80 3 3 9 9 9 85 80 5 3 25 9 15 60 50 0 -3 0 9 0 ∑ = 2 U ∑
=−2 V ∑ =140 2U ∑ =176 2V ∑ =141 UV
We have, defined variables U and V as
5 60−= XU and 5 65−= YV
Applying the Eq. (4.7)
( ) () () ∑∑∑∑ ∑ ∑ ∑ −− −
==2222 VVUNNU UVNUV
rr xyuv = 2))((2101762210140 2)2(10141 −−−− −− xxxx xx
=1760414004 14104 −− + =2451376 1414 = 0.9
So there is a high degree of positive correlation between marks
obtained in Mathematics and in Statistics.

Probable Error, denoted by PE (r) is given as rPEr 2 1.6745)0( − =
115() 10 .910.6745)0( 2 − =PEr .0405)0( =PEr So the value of r is
highly significant.
SPEARMAN’S RANK CORRELATION Sometimes we come
across statistical series in which the variables under consideration are
not capable of quantitative measurement but can be arranged in serial
order. This happens when we are dealing with qualitative
characteristics (attributes) such as honesty, beauty, character,
morality, etc., which cannot be measured quantitatively but can be
arranged serially. In such situations Karl Pearson’s coefficient of
correlation cannot be used as such. Charles Edward Spearman, a
British Psychologist, developed a formula in 1904, which consists in
obtaining the correlation coefficient between the ranks of N
individuals in the two attributes under study.
Suppose we want to find if two characteristics A, say, intelligence and
B, say, beauty are related or not. Both the characteristics are incapable
of quantitative measurements but we can arrange a group of N
individuals in order of merit (ranks) w.r.t. proficiency in the two
characteristics. Let the random variables X and Y denote the ranks of
the individuals in the characteristics A and B respectively. If we
assume that there is no tie, i.e., if no two individuals get the same rank
in a characteristic then, obviously, X and Y assume numerical values
ranging from 1 to N. The Pearsonian correlation coefficient between
the ranks X and Y is called the rank correlation coefficient between
the characteristics A and B for the group of individuals. Spearman’s
rank correlation coefficient, usually denoted by ρ(Rho) is given by the
equation ρ =1)( 6 1 2 2 − − ∑ NN d …………(4.8)
Where d is the difference between the pair of ranks of the same
individual in the two characteristics and N is the number of pairs.
Example Ten entries are submitted for a competition. Three judges
study each entry and list the ten in rank order. Their rankings are as
follows:
Entry: A B C D E F G H I J Judge J1: 9 3 7 5 1 6 2 4 10 8 Judge J2: 9
1 10 4 3 8 5 2 7 6 Judge J3: 6 3 8 7 2 4 1 5 9 10 Calculate the
appropriate rank correlation to help you answer the following
questions:

(i) Which pair of judges agrees the most? (ii) Which pair of judges
disagrees the most?
Solution: Calculations for Coefficient of Rank Correlation {Using
Eq.(4.8)} Rank by Judges Difference in Ranks Entry J1 J 2 J 3
d(J1&J2) d2 d(J1&J3) d2 d(J2&J3) d2 A 9 9 6 0 0 +3 9 +3 9 B 3 1 3
+2 4 0 0 -2 4 C 7 10 8 -3 9 -1 1 +2 4 D 5 4 7 +1 1 -2 4 -3 9 E 1 3 2 -2
4 -1 1 +1 1 F 6 8 4 -2 4 +2 4 +4 16 G 2 5 1 -3 9 +1 1 +4 16 H 4 2 5 +2
4 -1 1 -3 9 I 10 7 9 +3 9 +1 1 -2 4 J 8 6 10 +2 4 -2 4 -4 16 ∑d2 =48
∑d2 =26 ∑d2 =88
LIMITATIONS OF CORRELATION ANALYSIS
As mentioned earlier, correlation analysis is a statistical tool, which
should be properly used
so that correct results can be obtained. Sometimes, it is
indiscriminately used by management, resulting in misleading
conclusions. We give below some errors frequently made in the use of
correlation analysis:
1. Correlation analysis cannot determine cause-and-effect
relationship. One should notassume that a change in Y variable is
caused by a change in X variable unless one is reasonably sure that
one variable is the cause while the other is the effect. Let us take an
example. .
Suppose that we study the performance of students in their graduate
examination and their earnings after, say, three years of their
graduation. We may find that these two variables are highly and
positively related. At the same time, we must not forget that both the
variables might have been influenced by some other factors such as
quality of teachers, economic and social status of parents,
effectiveness of the interviewing process and so forth. If the data on
these factors are available, then it is worthwhile to use multiple
correlation analysis instead of bivariate one.
2. Another mistake that occurs frequently is on account of
misinterpretation of the coefficient of correlation. Suppose in one case
r = 0.7, it will be wrong to interpret that correlation explains 70
percent of the total variation in Y. The error can be seen easily when
we calculate the coefficient of determination. Here, the coefficient of

determination r2 will be 0.49. This means that only 49 percent of the
total variation in Y is explained.
Similarly, the coefficient of determination is misinterpreted if it is
also used to indicate causal relationship, that is, the percentage of the
change in one variable is due to the change in another variable.
3. Another mistake in the interpretation of the coefficient of
correlation occurs when one concludes a positive or negative
relationship even though the two variables are actually unrelated. For
example, the age of students and their score in the examination have
no relation with each other. The two variables may show similar
movements but there does not seem to be a common link between
them. To sum up, one has to be extremely careful while interpreting
coefficient of correlation. Before one concludes a causal relationship,
one has to consider other relevant factors that might have any
influence on the dependent variable or on both the variables. Such an
approach will avoid many of the pitfalls in the interpretation of the
coefficient of correlation. It has been rightly said that the coefficient
of correlation is not only one of the most widely used, but also one of
the widely abused statistical measures.
Regression
In business, several times it becomes necessary to have some forecast
so that the management can take a decision regarding a product or a
particular course of action. In order to make a forecast, one has to
ascertain some relationship between two or more variables relevant to
a particular situation. For example, a company is interested to know
how far the demand for television sets will increase in the next five
years, keeping in mind the growth of population in a certain town.
Here, it clearly assumes that the increase in population will lead to an
increased demand for television sets. Thus, to determine the nature
and extent of relationship between these two variables becomes
important for the company. In the preceding lesson, we studied in
some depth linear correlation between two variables. Here we have a
similar concern, the association between variables, except that we
develop it further in two respects. First, we learn how to build
statistical models of relationships between the variables to have a

better understanding of their features. Second, we extend the models
to consider their use in forecasting.
For this purpose, we have to use the technique - regression analysis -
which forms the subject-matter of this lesson.
WHAT IS REGRESSION?
In 1889, Sir Francis Galton, a cousin of Charles Darwin published a
paper on heredity,“Natural Inheritance”. He reported his discovery
that sizes of seeds of sweet pea plants appeared to “revert” or
“regress”, to the mean size in successive generations. He also reported
results of a study of the relationship between heights of fathers and
heights of their sons. A straight line was fit to the data pairs: height of
father versus height of son. Here, too, he found a “regression to
mediocrity” The heights of the sons represented a movement away
from their fathers, towards the average height. We credit Sir Galton
with the idea of statistical regression.
While most applications of regression analysis may have little to do
with the“regression to the mean” discovered by Galton, the term
“regression” remains. It now refers to the statistical technique of
modeling the relationship between two or more variables. In general
sense, regression analysis means the estimation or prediction of the
unknown value of one variable from the known value(s) of the other
variable(s). It is one of the most important and widely used statistical
techniques in almost all sciences - natural, social or physical.
In this lesson we will focus only on simple regression –linear
regression involving only two variables: a dependent variable and an
independent variable. Regression analysis for studying
more than two variables at a time is known as multiple regressions.
INDEPENDENT AND DEPENDENT VARIABLES
Simple regression involves only two variables; one variable is
predicted by another variable.The variable to be predicted is called the
dependent variable. The predictor is called the independent variable,
or explanatory variable. For example, when we are trying to predict
the demand for television sets on the basis of population growth, we
are using the demand for television sets as the dependent variable and
the population growth as the independent or predictor variable. The
decision, as to which variable is which sometimes, causes problems.

Often the choice is obvious, as in case of demand for television sets
and population growth because it would make no sense to suggest that
population growth could be dependent on TV demand! The
population growth has to be the independent variable and the TV
demand the dependent variable.
If we are unsure, here are some points that might be of use:
¾ if we have control over one of the variables then that is the
independent. For example, a manufacturer can decide how much to
spend on advertising and expect his sales to be dependent upon how
much he spends ¾ it there is any lapse of time between the two
variables being measured, then the latter must depend upon the
former, it cannot be the other way round ¾ if we want to predict the
values of one variable from your knowledge of the other variable, the
variable to be predicted must be dependent on the known one
LINEAR REGRESSION
The task of bringing out linear relationship consists of developing
methods of fitting a straight line, or a regression line as is often called,
to the data on two variables. The line of Regression is the graphical or
relationship representation of the best estimate of one variable for any
given value of the other variable. The nomenclature of the line
depends on the independent and dependent variables. If X and Y are
two variables of which relationship is to be indicated, a line that gives
best estimate of Y for any value of X, it is called Regression line of Y
on X. If the dependent variable changes to X, then best estimate of X
by any value of Y is called Regression line of X on Y.
REGRESSION LINE OF Y ON X
For purposes of illustration as to how a straight line relationship is
obtained, consider the sample paired data on sales of each of the N =
5 months of a year and the marketing expenditure incurred in each
month,
Month Sales (Rs lac) Marketing Expenditure (Rs thousands)
Y X April 14 10 May 17 12 June 23 15 July 21 20 August 25 23
Let Y, the sales, be the dependent variable and X, the marketing
expenditure, the independent variable. We note that for each value of
independent variable X, there is a specific value of the dependent

variable Y, so that each value of X and Y can be seen as paired
observations.
Scatter Diagram
Before obtaining a straight-line relationship, it is necessary to
discover whether the relationship between the two variables is linear,
that is, the one which is best explained by a straight line. A good way
of doing this is to plot the data on X and Y on a graph so as to yield a
scatter diagram, as may be seen in Figure 5-1. A careful reading of the
scatter diagram reveals that:
¾ the overall tendency of the points is to move upward, so the
relationship is positive ¾ the general course of movement of the
various points on the diagram can be best explained by a straight line
¾ there is a high degree of correlation between the variables, as the
points are very close to each other
Scatter Diagram with Line of Best Fit
Fitting a Straight Line on the Scatter Diagram
If the movement of various points on the scatter diagram is best
described by a straight line, the next step is to fit a straight line on the
scatter diagram. It has to be so fitted that on the whole it lies as close
as possible to every point on the scatter diagram. The necessary
requirement for meeting this condition being that the sum of the
squares of the vertical deviations of the observed Y values from the
straight line is minimum. As shown in Figure 5-1, if dl, d2,..., dN are
the vertical deviations' of observed Y values from the straight line,
fitting a straight line requires that ∑=+=++
Nj Nj dddd 1 222 2 2 1 ........... is the minimum. The deviations dj
have to be squared to avoid negative deviations canceling out the
positive deviations. Since a straight line so fitted best approximates all
the points on the scatter diagram, it is better known as the best
approximating line or the line of best fit. A line of best fit can be
fitted by means of:
1. Free hand drawing method, and
2. Least square method
Free Hand Drawing: Free hand drawing is the simplest method of
fitting a straight line. After a careful inspection of the movement and
spread of various points on the scatter diagram, a straight line is

drawn through these points by using a transparent ruler such that on
the whole it is closest to every point. A straight line so drawn is
particularly useful when future approximations of the dependent
variable are promptly required.
Whereas the use of free hand drawing may yield a line nearest to the
line of best fit, the major drawback is that the slope of the line so
drawn varies from person to person because of the influence of
subjectivity. Consequently, the values of the dependent variable
estimated on the basis of such a line may not be as accurate and
precise as those based on the line of best fit.
Least Square Method:
The least square method of fitting a line of best fit requires
minimizing the sum of the squares of vertical deviations of each
observed Y value from the fitted line. These deviations, such as d1
and d3, are shown in Figure 5-1 and are given by Y - Yc, where Y is
the observed value and Yc the corresponding computed value given
by the fitted line
ci abXY += …………(5.1) for the ith value of X.
The straight line relationship in Eq.(5.1), is stated in terms of two
constants a and b ¾ The constant a is the Y-intercept; it indicates the
height on the vertical axis from where the straight line originates,
representing the value of Y when X is zero.
¾ Constant b is a measure of the slope of the straight line; it shows
the absolute change in Y for a unit change in X. As the slope may be
positive or negative, it indicates the nature of relationship between Y
and X. Accordingly, b is also known as the regression coefficient of Y
on X.
Since a straight line is completely defined by its intercept a and slope
b, the task of fitting the same reduces only to the computation of the
values of these two constants. Once these two values are known, the
computed Yc values against each value of X can be easily obtained by
substituting X values in the linear equation.
In the method of least squares the values of a and b are obtained by
solving simultaneously the following pair of normal equations ∑ ∑
=+bX YaN …………(5.2) ∑∑∑ =+ 2 bXaXXY …………(5.2)
The value of the expressions - ∑ ∑ , , XY ∑XY and ∑ 2 X can be

obtained from the given observations and then can be substituted in
the above equations to obtain the value of a and b.
Since simultaneous solving the two normal equations for a and b may
quite often be cumbersome and time consuming, the two values can
be directly obtained as a = bX Y − …………(5.3)
and
() ∑∑ ∑ ∑ ∑ − − = 2 2 XXN XYNXY b …………(5.4)
Note: Eq. (5.3) is obtained simply by dividing both sides of the first of
Eqs. (5.2) by N and Eq.(5.4) is obtained by substituting ( bX Y − ) in
place of a in the second of Eqs. (5.2)
Instead of directly computing b, we may first compute value of a as ()
∑∑ ∑ ∑ ∑ ∑ − − = 2 2 2 XXN XXYYX a …………(5.5)
and
b=
X Ya −
…………(5.6)
Note: Eq. (5.5) is obtained by substituting () ∑∑ ∑ ∑ ∑ − − 22 XXN
XYNXY for b in Eq. (5.3) and Eq. (5.6) is obtained simply by
rearranging Eq. (5.3)
Computation of a and b Y X XY X2 Y 2
14 10 140 100 196 17 12 204 144 289 23 15 345 225 529 21 20 420
400 441 25 23 575 529 625 ∑ =100 Y ∑ =80 X ∑ =1684 XY ∑
=1398 2X ∑ = 2080 2Y
So using Eqs. (5.5) and (5.4)
() 21398805 8016841001398 =x xxa 69906400 139800134720 − − =
= 590 5080 = 8.6101695
and () 21398805 8010051684 − −=x xxb 69906400 84208000 = 590
420 = 0.7118644
Now given a = 8.61 and b = 0.71.
The regression Eq.(5.1) takes the form
Yc = 8.61 + 0.71X …………(5.1a)
Regression Line of Y on X
Then, to fit the line of best fit on the scatter diagram, only two
computed Yc values are needed. These can be easily obtained by
substituting any two values of X in Eq. (5.1a). When these are plotted
on the diagram against their corresponding values of X, we get two

points, by joining which (by means of a straight line) gives us the
required line of best fit,
REGRESSION LINE OF X ON Y
So far we have considered the regression of Y on X, in the sense that
Y was in the role of dependent and X in the role of an independent
variable. In their reverse position, such that X is now the dependent
and Y the independent variable, we fit a line of regression of X on Y.
The regression equation in this case will be
Xc = a’ + b’Y …………(5.13) Where Xc denotes the computed
values of X against the corresponding values of Y. a’ is the X-
intercept and b’ is the slope of the straight line. Two normal equations
to solve a’and b’ are ∑∑ =+bY aNX '' …………(5.14) ∑∑∑ =+ 2
''bY aYXY …………(5.14)
The value of a’ and b’ can also be obtained directly a’ = X - b’Y
…………(5.15)
and () ∑∑ ∑ ∑ ∑ − − = 2 2
YN XYNXY b …………(5.16)
or
() ∑∑ ∑ ∑ ∑ ∑ − − = 2 2 2
'YYN YXYXY a …………(5.17)
and
Y Xab ' ' − = …………(5.18)
2 )(,' yS YXCovb = …………(5.19)
Yxyx S Sbr = ' …………(5.20)
So, Regression equation of X on Y may also be written as Xc - X =
b’ (Y-Y ) …………(5.21)
Xc - X = yxyx S Sr (Y - Y ) …………(5.22)
As before, once the values of a’ and b’ have been found, their
substitution in Eq.(5.13) will enable us to get an estimate of X
corresponding to a known value of Y Standard Error of estimate of X
on Y i.e. Sxy will be Sxy = () N XXc 2 − …………(5.23)
or
Sxy = N bXYaXX ∑ ∑ ∑ −− ''2 …………(5.24)
For example, if we want to estimate the marketing expenditure to
achieve a sale target of Rs 40 lac, we have to obtain regression line of
X on Y i. e.

Xc = a’ + b’Y So using Eqs. (5.17) and (5.16), and substituting the
values of ∑ ∑∑ ∑ YXY XY and , , 2
, we have () 220801005 1001684802080' − − = x xxa 1040010000
166400168400 = 400 2000− = -5.00 and
() 220801005 8010051684' − − = x xxb 1040010000 84208000 − − =
146 = 400 420 = 1.05
Now given that a’= -5.00 and b’=1.05, Regression equation (5.13)
takes the form
Xc = -5.00 +1.05Y
So when Y = 40(Rs lac), the corresponding X value is
Xc = -5.00+1.05x40 = -5 + 42 = 37
That is to achieve a sale target of Rs 40 lac, there is a need to spend
Rs 37 thousand on
marketing.
PROPERTIES OF REGRESSION COEFFICIENTS As explained
earlier, the slope of regression line is called the regression coefficient.
It tells the effect on dependent variable if there is a unit change in the
independent variable. Since for a paired data on X and Y variables,
there are two regression lines: regression line of Y on X and
regression line of X on Y, so we have two regression coefficients:
a. Regression coefficient of Y on X, denoted by byx [b in Eq.(5.1)] b.
Regression coefficient of X on Y, denoted by bxy [b’ in Eq.(5.13)]
The following are the important properties of regression coefficients
that are helpful in data analysis
1. The value of both the regression coefficients cannot be greater than
1. However, value of both the coefficients can be below 1 or at least
one of them must be below 1, so that the square root of the product of
two regression coefficients must lie in the limit ±1.
2. Coefficient of correlation is the geometric mean of the regression
coefficients, i.e.
r = ± ' . bb …………(5.25)
The signs of both the regression coefficients are the same, and so the
value of r will also have the same sign.
3. The mean of both the regression coefficients is either equal to or
greater than the coefficient of correlation, i.e. r bb ≥ + 2 '

3. Regression coefficients are independent of change of origin but not
of change of scale. Mathematically, if given variables X and Y are
transformed to new variables U and V by change of origin and scale,
i. e. U = k YBV
h XA − = − and
Where A, B, h and k are constants, h > 0, k > 0 then Regression
coefficient of Y on X = k/h (Regression coefficient of V on U)
yxvu b h kb = and
Regression coefficient of X on Y = h/k (Regression coefficient of U
on V) xyuv b k hb
5. Coefficient of determination is the product of both the regression
coefficients i.e. r2 = b.b’
REGRESSION LINES AND COEFFICIENT OF
CORRELATION
The two regression lines indicate the nature and extent of correlation
between the variables.
The two regression lines can be represented as Y - Y = xyS S r (X -
X ) and X - X = yx
S S r (Y - Y )
We can write the slope of these lines, as b = xy
S S r and b’ = yxS S r If θ is the angle between these lines, then
tan θ =
1' ' bb bb + − + r r SS SS xy xy 1 2 22 or θ = tan –1 − + r r SS SS xy
xy 1 2 22 …………(5.26)
Regression Lines and Coefficient of Correlation Eq. (5.26) reveals
the following:
¾ In case of perfect positive correlation (r = +1) and in case of perfect
negative correlation (r = -1), θ = 0, so the two regression lines will
coincide, i.e. we have only one line, see (a) and (b) in
The farther the two regression lines from each other, lesser will be the
degree of correlation and nearer the two regression lines, more will be
the degree of correlation,
¾ If the variables are independent i.e. r = 0, the lines of regression
will cut each other at right angle.
Note : Both the regression lines cut each other at mean value of X and
mean value of Y i.e. at X and Y.

COEFFICIENT OF DETERMINATION Coefficient of
determination gives the percentage variation in the dependent variable
that is accounted for by the independent variable. In other words, the
coefficient of determination gives the ratio of the explained variance
to the total variance. The coefficient of determination is given by the
square of the correlation coefficient, i.e. r2. Thus,
Coefficient of determination r2 =TotalVariance ExplainedVariance
r2 = () ()∑ ∑ − − 2 2 YY YY c …………(5.27)
We can calculate another coefficient K2, known as coefficient of
Non-Determination, which is the ratio of unexplained variance to the
total variance. K2 =TotalVariance explainedVarianceUn exp
K2 = () ()∑ ∑ − − 2 2 YY YYc …………(5.28)
K2 = 1- TotalVariance ExplainedVariance = 1 - r2
…………(5.29)
The square root of the coefficient of non-determination, i.e. K gives
the coefficient of alienation
K = ± 2 1 r − …………(5.30)
Relation Between Syx and r:
A simple algebraic operation on Eq. (5.30) brings out some
interesting points about the relation between Syx and r. Thus, since ()
2 2 cyx NSYY −=∑ and ( ) 2 2 y NSYY −=∑ .
So we have coefficient of Non-determination () () 2 2 2 ∑ ∑ − − =
YY YY K c K2 = 2 2 y yx NS NS 22yyxS S = So 1 – r2 2 2 y
yx S S =
If coefficient of correlation, r, is defined as the under root of the
coefficient of determination
r = 2 r ,r2 = 2 2 1 y yx S S − 21 y yx S S r =− …………(5.32)
On carefully observing Eq. (5.32), it will be noticed that the ratio
Syx/Sy will be large if the coefficient of determination is small, and it
will be small when the coefficient of determination is large. Thus 9 if
r2 = r = 0, Syx/Sy =1, which means that Syx = Sy. 9 if r2 = r = 1,
Syx/Sy =0, which means that Syx = 0. 9 when r = 0.865, Syx = 0.427
Sy means that Syx is 42.7% of Sy. Eq. (5.32) also implies that Syx is
generally less than Sy. The two can at the most be equal, but only in
the extreme situation when r = 0. Interpretations of r2:

1. Even though the coefficient of determination, whose under root
measures the degree of correlation, is based on Syx,; it is expressed as
1 - ( Syx/Sy ). As it is a dimensionless pure number, the unit in which
Syx is measured becomes irrelevant. This facilitates comparison
between the two sets of data in terms of their coefficient of
determination r2 (or the coefficient of correlation r). This was not
possible in terms of Sy x as the units of measurement could be
different. 2. The value of r2 can range between 0 and 1. When r2 = 1,
all the points on the scatter diagram fall on the regression line and the
entire variations are explained by the straight line. On the other hand,
when r2 = 0, none of the points on the scatter diagram falls on the
regression line, meaning thereby that there is no relationship between
the two variables. However, being always non-negative coefficient of
determination does not tell us about the direction of the relationship
(whether it is positive or negative) between the two variables. 3.
When r2 = 0.7455 (or any other value), 74.55% of the total variations
in sales are explained by the marketing expenditure used. What
remains is the coefficient of nondetermination K2 (= 1 - r2) = 0.2545.
It means 25.45% of the total variations remain unexplained, which are
due to factors other than the changes in the marketing expenditure. 4.
r2 provides the necessary link between regression and correlation
which are the tworelated aspects of a single problem of the analysis of
relationship between two variables. Unlike regression, correlation
quantifies the degrees of relationship between the variables under
study, without making a distinction between the dependent and
independent ones. Nor does it, therefore, help in predicting the value
of one variable for a given value of the other.
5. The coefficient of correlation overstates the degree of relationship
and it’s meaning is not as explicit as that of the coefficient of
determination. The coefficient of correlation r = 0.865, as compared
to r2 = 0.7455, indicates a higher degree of correlation between sales
and marketing expenditure. Therefore, the coefficient of'
determination is a more objective measure of the degree of
relationship.

6. The sum of r and K never adds to one, unless one of the two is
zero. That is, r + K can be unity either when there is no correlation or
when there is perfect correlation.
Except in these two extreme situations, (r + K) > 1. 5.7
CORRELATION ANALYSIS VERSUS REGRESSION
ANALYSIS Correlation and Regression are the two related aspects of
a single problem of the analysis of the relationship between the
variables. If we have information on more than one variable, we
might be interested in seeing if there is any connection - any
association - between them. If we found such a association, we might
again be interested in predicting the value of one variable for the
given and known values of other variable(s).
1. Correlation literally means the relationship between two or more
variables that vary in sympathy so that the movements in one tend to
be accompanied by the corresponding movements in the other(s). On
the other hand, regression means stepping back or returning to the
average value and is a mathematical measure expressing the average
relationship between the two variables.
2. Correlation coefficient rxy between two variables X and Y is a
measure of the direction and degree of the linear relationship between
two variables that is mutual. It is symmetric, i.e., ryx = rxy and it is
immaterial which of X and Y is dependent variable and which is
independent variable.
Regression analysis aims at establishing the functional relationship
between the two( or more) variables under study and then using this
relationship to predict or estimate the value of the dependent variable
for any given value of the independent variable(s) It also reflects upon
the nature of the variable, i.e., which is dependent variable and which
is independent variable. Regression coefficient are not symmetric in
X and Y, i.e., byx ≠ bxy.
3. Correlation need not imply cause and effect relationship between
the variable under study. However, regression analysis clearly
indicates the cause and effect relationship between the variables. The
variable corresponding to cause is taken as independent variable and
the variable corresponding to effect is taken as dependent variable.

4. Correlation coefficient rxy is a relative measure of the linear
relationship between X and Y and is independent of the units of
measurement. It is a pure number lying between ±1.
On the other hand, the regression coefficients, byx and bxy are
absolute measures representing the change in the value of the variable
Y (or X), for a unit change in the value of the variable X (or Y). Once
the functional form of regression curve is known;by substituting the
value of the independent variable we can obtain the value of the
dependent variable and this value will be in the units of measurement
of the dependent variable.
5. There may be non-sense correlation between two variables that is
due to pure chance and has no practical relevance, e.g., the
correlation, between the size of shoe and theintelligence of a group of
individuals. There is no such thing like non-sense regression.

UNIT4
Index Number
In business, managers and other decision makers may be concerned
with the way in which the values of variables change over time like
prices paid for raw materials, numbers of employees and customers,
annual income and profits, and so on. Index numbers are one way of
describing such changes.
If we turn to any journal devoted to economic and financial matters,
we are very likely to come across an index number of one or the other
type. It may be an index number of share prices or a wholesale price
index or a consumer price index or an index of industrial production.
The objective of these index numbers is to measure the changes that
have occurred in prices, cost of living, production, and so forth. For
example, if a wholesale price index number for the year 2000 with
base year 1990 was 170; it shows that wholesale prices, in general,
increased by 70 percent in 2000 as compared to those in 1990. Now,
if the same index number moves to 180 in 2001, it shows that there
has been 80 percent increase in wholesale prices in 2001 as compared
to those in 1990. With the help of various index numbers, economists
and businessmen are able to describe and appreciate business and
economic situations quantitatively. Index numbers were originally
developed by economists for monitoring and comparing different
groups of goods. It is necessary in business to understand and
manipulate the different published index series, and to construct index
series of your own. Having constructed your own index, it can then be
compared to a national one such as the RPI, a similar index for your
industry as a whole and also to indexes for your competitors. These
comparisons are a very useful tool for decision making in business.
For example, an accountant of a supermarket chain could construct an
index of the company's own sales and compare it to the index of the
volume of sales for the general supermarket industry. A graph of the
two indexes will illustrate the company's performance within the
sector. It is immediately clear from Figure 6-1 that, after initially
lagging behind the general market, the supermarket company caught
up and then overtook it. In the later stages, the company was having

better results than the general market but that, as with the whole
industry, those had levelled out.
Our focus in this lesson will be on the discussion related to the
methodology of index number construction. The scope of the lesson is
rather limited and as such, it does not discuss a large number of index
numbers that are presently compiled and published by different
departments of the Government of India.
WHAT ARE INDEX NUMBERS? “Index numbers are statistical
devices designed to measure the relative changes in the level of a
certain phenomenon in two or more situations”. The phenomenon
under consideration may be any field of quantitative measurements. It
may refer to a single variable or a group of distinct but related
variables. In Business and Economics, the phenomenon under
consideration may be:
the prices of a particular commodity like steel, gold, leather, etc. or a
group of commodities like consumer goods, cereals, milk and milk
products, cosmetics, etc. volume of trade, factory production,
industrial or agricultural production, imports or exports, stocks and
shares, sales and profits of a business house and so on. the national
income of a country, wage structure of workers in various sectors,
bank deposits, foreign exchange reserves, cost of living of persons of
a particular
community, class or profession and so on.
The various situations requiring comparison may refer to either the
changes occurring over a time, or the difference(s) between two or
more places, or the variations between similar categories of
objects/subjects, such as persons, groups of persons, organisations etc.
or other characteristics such as income, profession, etc.
The utility of index numbers in facilitating comparison may be seen
when, for example we are interested in studying the general change in
the price level of consumer goods, i.e. good or commodities
consumed by the people belonging to a particular section of society,
say, low income group or middle income group or labour class and so
on. Obviously these changes are not directly measurable as the price
quotations of the various commodities are available in different units,
e.g., cereals (wheat, rice, pulses, etc) are quoted in Rs per quintal or

kg; water in Rs per gallon; milk, petrol, kerosene, etc. in Rs per liter;
cloth in Rs per miter and so on.
Further, the prices of some of the commodities may be increasing
while those of others may be decreasing during the two periods and
the rates of increase or decrease may be different for different
commodities. Index number is a statistical device, which enables us to
arrive at a single representative figure that gives the general level of
the price of the phenomenon (commodities) in an extensive group.
According to Wheldon: “Index number is a statistical device for
indicating the relative movements of the data where measurement of
actual movements is difficult or incapable of being made.”
FY Edgeworth gave the classical definition of index numbers as
follows:
.“Index number shows by its variations the changes in a magnitude
which is not susceptible either of accurate measurement in itself or of
direct valuation in practice.” On the basis of above discussion, the
following characteristics of index numbers are apparent:
1. Index Numbers are specialized averages: An average is a
summary figure measuring the central tendency of the data,
representing a group of figures. Index number has all these functions
to perform. L R Connor states, "in its simplest form, it (index number)
represents a special case of an average, generally a weighted average
compiled from a sample of items judged to be representative of the
whole". It is a special type of average – it averages variables having
different units of measurement.
2. Index Numbers are expressed in percentages: Index numbers are
expressed in terms of percentages so as to show the extent of change.
However, percentage sign (%) is never used.
3. Index Numbers measure changes not capable of direct
measurement: The technique of index numbers is utilized in
measuring changes in magnitude, which are not capable of direct
measurement. Such magnitudes do not exist in themselves.
Examples of such magnitudes are 'price level', 'cost of living',
'business or economic activity' etc. The statistical methods used in the
construction of index numbers are largely methods for combining a
number of phenomena representing a particular magnitude in such a

manner that the changes in that magnitude may be measured in a
meaningful way without introduction of serious bias.
4. Index Numbers are for comparison: The index numbers by their
nature are comparative. They compare changes taking place over time
or between places or between like categories.
In brief, index number is a statistical technique used in measuring the
composite change in several similar economic variables over time. It
measures only the composite change, because some of the variables
included may be showing an increase, while some others may be
showing a decrease. It synthesizes the changes taking place in
different directions and by varying extents into the one composite
change. Thus, an index number is a device to simplify comparison to
show relative movements of the data concerned and to replace what
may be complicated figures by simple ones calculated on a percentage
basis.
USES OF INDEX NUMBER
The first index number was constructed by an Italian, Mr G R Carli,
in 1764 to compare the changes in price for the year 1750 (current
year) with the price level in 1500 (base year) in order to study the
effect of discovery of America on the price level in Italy. Though
originally designed to study the general level of prices or accordingly
purchasing power of money, today index numbers are extensively
used for a variety of purposes in economics, business, management,
etc., and for quantitative data relating to production, consumption,
profits, personnel and financial matters etc., for comparing changes in
the level of phenomenon for two periods, places, etc. In fact there is
hardly any field or quantitative measurements where index numbers
are not constructed. They are used in almost all sciences – natural,
social and physical. The main uses of index numbers can be
summarized as follows:
1. Index Numbers as Economic Barometers:Index numbers are
indispensable tools for the management personnel of any government
organisation or individual business concern and in business planning
and formulation of executive decisions. The indices of prices
(wholesale & retail), output (volume of trade, import and export,
industrial and agricultural production) and bank

deposits, foreign exchange and reserves etc., throw light on the nature
of, and variation in the general economic and business activity of the
country. They are the indicators of business environment. A careful
study of these indices gives us a fairly good appraisal of the general
trade, economic development and business activity of the country. In
the world of G Simpson and F Kafka:
“Index numbers are today one of the most widely used statistical
devices. They arused to take the pulse of the economy and they have
come to be used as indicators of inflationary or deflationary
tendencies.” Like barometers, which are used in Physics and
Chemistry to measure atmospheric
pressure, index numbers are rightly termed as “economic
barometers”, which measure the pressure of economic and business
behaviour.
2. Index Numbers Help in Studying Trends and Tendencies Since
the index numbers study the relative change in the level of a
phenomenon at different periods of time, they are especially useful for
the study of the general trend for a group phenomenon in time series
data. The indices of output (industrial and agricultural production),
volume of trade, import and export, etc., are extremely useful for
studying the changes in the level of phenomenon due to the various
components of a time series, viz. secular trend, seasonal and cyclical
variations and irregular components and reflect upon the general trend
of production and business activity. As a measure of average change
in extensive group, the index numbers can be used to forecast future
events. For instance, if a businessman is interested in establishing a
new undertaking, the study of the trend of changes in the prices,
wages and incomes in different industries is extremely helpful to him
to frame a general idea of the comparative courses, which the future
holds for different undertakings.
3. Index Numbers Help in Formulating Decisions and Policies
Index numbers of the data relating to various business and economic
variables serve an important guide to the formulation of appropriate
policy. For example, the cost of living index numbers are used by the
government and, the industrial and business concerns for the
regulation of dearness allowance (D.A.) or grant of bonus to the

workers so as to enable them to meet the increased cost of living from
time to time.
The excise duty on the production or sales of a commodity is
regulated according to the index numbers of the consumption of the
commodity from time to time. Similarly, the indices of consumption
of various commodities help in the planning of their future
production. Although index numbers are now widely used to study the
general economic and business conditions of the society, they are also
applied with advantage by sociologists (population indices),
psychologists (IQs’), health and educational authorities etc., for
formulating and revising their policies from time to time.
4. Price Indices Measure the Purchasing Power of Money A
traditional use of index numbers is in measuring the purchasing power
of money. Since the changes in prices and purchasing power of
money are inversely related, an increase in the general price index
indicates that the purchasing power of money has gone down.
In general, the purchasing power of money may be computed as
PriceIndexGeneral 1 PowerPurchasing x = Accordingly, if the
consumer price index for a given year is 150, the purchasing power of
a rupee is (1/150) 100 = 0.67. That is, the purchasing power of a rupee
in the given year is 67 paise as compared to the base year.
With the increase in prices, the amount of goods and services which
money wages can
buy (or the real wages) goes on decreasing. Index numbers tell us the
change in real wages, which are obtained as PriceIndexConsumer
Money Wage Wage Real x = A real wage index equal to, say, 120
corresponding to money wage index of 160 will indicate an increase
in real wages by only 20 per cent as against 60 per cent increase in
money wages.
Index numbers also serve as the basis of determining the terms of
exchange. The terms of exchange are the parity rate at which one set
of commodities is exchanged for another set of commodities. It is
determined by taking the ratio of the price index for the two groups of
commodities and expressing it in percentage.
For example, if A and B are the two groups of commodities with 120
and 150 as their price index in a particular year, respectively, the ratio

120/150 multiplied by 100 is 80 per cent. It means that prices of A
group of commodities in terms of those in group B are lower by 20
per cent.
5. Index Numbers are Used for Deflation Consumer price indices
or cost of living index numbers are used for deflation of net national
product, income value series in national accounts. The technique of
obtaining real wages from the given nominal wages (as explained in
use 4 above) can be used to find real income from inflated money
income, real sales from nominal sales and so on by taking into
account appropriate index numbers.
TYPES OF INDEX NUMBERS Index numbers may be broadly
classified into various categories depending upon the type of the
phenomenon they study. Although index numbers can be constructed
for measuring relative changes in any field of quantitative
measurement, we shall primarily confine the discussion to the data
relating to economics and business i.e., data relating to prices,
production (output) and consumption. In this context index numbers
may be broadly classified into the following three categories:
1. Price Index Numbers: The price index numbers measure the
general changes in the prices. They are further sub-divided into the
following classes: (i) Wholesale Price Index Numbers: The
wholesale price index numbers reflect the changes in the general price
level of a country. (ii) Retail Price Index Numbers: These indices
reflect the general changes in the retail prices of various commodities
such as consumption goods, stocks and shares, bank deposits,
government bonds, etc. (iii) Consumer Price Index: Commonly
known as the Cost of living Index, CPI is a specialized kind of retail
price index and enables us to study the effect of changes in the price
of a basket of goods or commodities on the purchasing power or cost
of living of a particular class or section of the people like labour class,
industrial or agricultural worker, low income or middle income class
etc.
2. Quantity Index Numbers: Quantity index numbers study the
changes in the volume of goods produced (manufactured), consumed
or distributed, like: the indices of agricultural production, industrial

production, imports and exports, etc. They are extremely helpful in
studying the level of physical output in an economy.
3. Value Index Numbers: These are intended to study the change in
the total value (price multiplied by quantity) of output such as indices
of retail sales or profits or inventories. However, these indices are not
as common as price and quantity indices.
Notations Used Since index numbers are computed for prices,
quantities, and values, these are denoted by the lower case letters: p,
q, and v represent respectively the price, the quantity, and the value
of an individual commodity.
Subscripts 0, 1, 2,… i, ... are attached to these lower case letters to
distinguish price, quantity, or value in any one period from those in
the other. Thus, p0 denotes the price of a commodity in the base
period, p1 denotes the price of a commodity in period 1, or the
current period, and p i denotes the price of a commodity in the ith
period, where i = 1,2,3, ... Similar meanings are assigned to q0, q1, ...
qi, ... and v0, v1, … vi, …
Capital letters P, Q and V are used to represent the price, quantity,
and value index numbers, respectively. Subscripts attached to P, Q,
and V indicates the years compared. Thus, P OI means the price
index for period 1 relative to period 0, P02 means the price index for
period 2 relative to period 0, PI2 means the price index for period 2
relative to period 1, and so on.
Similar meanings are assigned to quantity Q and value V indices. It
may be noted that all indices are expressed in percent with 100 as the
index for the base period, the period with which comparison is to be
made.
Various indices can also be distinguished on the basis of the number
of commodities that go into the construction of an index. Indices
constructed for individual commodities or variable are termed as
simple index numbers. Those constructed for a group of commodities
or variables are known as aggregative (or composite) index numbers.
Here, in this lesson, we will develop methods of constructing simple
as well as composite indices.
SIMPLE INDEX NUMBERS A simple price index number is based
on the price or quantity of a single commodity. To construct a simple

index, we first have to decide on the base period and then find ratio of
the value at any subsequent period to the value in that base period -
the price/quantity relative.
This ratio is then finally converted to a percentage 100
Yearin BaseValue Period in Value any PeriodIndex for x ii = i.e.
Simple Price Index for period i = 1,2,3 ... will be 100
0 0 x p p P i i = …………(6-1) Similarly, Simple Quantity Index for
period i = 1,2,3 ... will be 100
0 0 x q q Q i i = …………(6-2)
Example Given are the following price-quantity data of fish, with
price quoted in Rs per kg and production in qtls. Year : 1980 1981
1982 1983 1984 1985 Price : 15 17 16 18 22 20 Production :
500 550 480 610 650 600 Construct: (a) the price index for each
year taking price of 1980 as base, (b) the quantity index for each
year taking quantity of 1980 as base. Solution: Simple Price and
Quantity Indices of Fish (Base Year = 1980) Year Price (pi)
Quantity (qi) Price Index 100 0 0 x p p P i i = Quantity Index 100 0
0 x q q Q i i = 182
1980 1981 1982 1983 1984 1985
15 17 16 18 22 20
500 550 480 610 650 600
100.00 113.33 106.66 120.00 146.66 133.33
100.00 110.00 96.00 122.00 130.00 120.00
These simple indices facilitate comparison by transforming absolute
quantities/pricesinto percentages. Given such an index, it is easy to
find the percent by which the price/quantity may have changed in a
given period as compared to the base period. For example, observing
the index computed in Example 6-1, one can firmly say that the
output of fish was 30 per cent more in 1984 as compared to 1980.
It may also be noted that given the simple price/quantity for the base
year and the index for the period i = 1, 2, 3, …; the actual
price/quantity for the period i = 1, 2, 3, … may easily be obtained as:
100 00 I i Ppp …………(6-3)
and ⎛= 100 0 0 i i Qqq …………(6-4)
For example, with i = 1983, Q0i = 122.00, and q0 = 500,
=100 .00122500iq = 610

COMPOSITE INDEX NUMBERS The preceding discussion was
confined to only one commodity. What about price/quantity changes
in several commodities? In such cases, composite index numbers are
used. Depending upon the method used for constructing an index,
composite indices may be:
1. Simple Aggregative Price/ Quantity Index
2. Index of Average of Price/Quantity Relatives
3. Weighted Aggregative Price/ Quantity Index
4. Index of Weighted Average of Price/Quantity Relatives
SIMPLE AGGREGATIVE PRICE/ QUANTITY INDEX
Irrespective of the units in which prices/quantities are quoted, this
index for given prices/quantities, of a group of commodities is
constructed in the following three steps:
(i) Find the aggregate of prices/quantities of all commodities for each
period (or place). (ii) Selecting one period as the base, divide the
aggregate prices/quantities
corresponding to each period (or place) by the aggregate of prices/
quantities in the base period.
(iii) Express the result in percent by multiplying by 100.
The computation procedure contained in the above steps can be
expressed as:
1000 0 x p p P i i ∑ ∑= …………(6-5)
and 100 0 0 x q q Q i i ∑ ∑= …………(6-6)
Example Given are the following price-quantity data, with price
quoted in Rs per kg and production in qtls.
1980 1985 Item Price Production Price Production
Fish 15 500 20 600 Mutton 18 590 23
640
184
Chicken 22 450 24 500
Find (a) Simple Aggregative Price Index with 1980 as the base. (b)
Simple Aggregative Quantity Index with 1980 as the base.
Solution:
Calculations for Simple Aggregative Price and Quantity Indices
(Base Year = 1980) Item Prices 1980(p0) 1985(pi) Quantities
1980(q0) 1985(qi) Fish 15 20 500

600 Mutton 18 23 590 640
Chicken 22 24 450 500 Sum → 55
67 1540 1740
(a) Simple Aggregative Price Index with 1980 as the base 100
This limitation renders the index of no practical utility.
Second, different units in which the prices are quoted also sometimes
unduly affect this index. Prices quoted in higher weights, such as
price of wheat per bushel as compared to a price per kg, will have
unduly large influence on this index. Consequently, the prices of only
a few commodities may dominate the index. This problem no longer
exists when the units in which the prices of various commodities are
quoted have a common base. Even the condition of common base will
provide no real solution because commodities with relatively high
prices such as gold, which is not as important as milk, will continue to
dominate this index excessively. For example, in the Example given
above chicken prices are relatively higher than those of fish, and
hence chicken prices tend to influence this index relatively more than
the prices of fish.
INDEX OF AVERAGE OF PRICE/QUANTITY RELATIVES
This index makes an improvement over the index of simple
aggregative prices/quantities as it is not affected by the difference in
the units of measurement in which prices/quantities are expressed.
However, this also suffers from the problem of equal importance
getting assigned to all the commodities. Given the prices/quantities of
a number of commodities that enter into the construction of this
index, it is computed in the following two steps:
(i) After selecting the base year, find the price relative/quantity
relative of each commodity for each year with respect to the base year
price/quantity. As defined earlier, the price relative/quantity relative
of a commodity for a given period is the ratio of the price/quantity of
that commodity in the given period to its price/quantity in the base
period.
(ii) Multiply the result for each commodity by 100, to get simple
price/quantity indices for each commodity.
(iii) Take the average of the simple price/quantity indices by using
arithmetic mean, geometric mean or median.

WEIGHTED AGGREGATIVE PRICE/QUANTITY INDICES
We have noted that the simple aggregative price/quantity indices do
not take care of the differences in the weights to be assigned to
different commodities that enter into their construction. It is primarily
because of this limitation that the simple aggregative indices are of
very limited use. Weighted aggregative Indices make up this
deficiency by assigning proper weights to individual items.
Among several ways of assigning weights, two widely used ways are:
(i) to use base period quantities/prices as weights, popularly known as
Laspeyre's Index, and (ii) to use the given (current) period
quantities/prices as weights, popularly known as Paasche's Index.
Laspeyre’s Index
Laspeyre’s Price Index, using base period quantities as weights is
obtained as
100
Paasche’s Index
Paasche’s Price Index, using base period quantities as weights is
obtained as
100
0 0 x pq pq P i iiPa i ∑ ∑= …………(6-13)
Paasche’s Quantity Index, using base period prices as weights is
obtained as
100
Example From the data in Example 6.2 find:
(a) Laspeyre’s Price Index for 1985, using 1980 as the base
(b) Laspeyre’s Quantity Index for 1985, using 1980 as the base
(c) Paasche’s Price Index for 1985, using 1980 as the base 190
(d) Paasche’s Quantity Index for 1985, using 1980 as the base
Relationship Between Laspeyre’s and Paasche’s Indices
In order to understand the relationship between Laspeyre’s and
Paasche’s Indices, the assumptions on which the two indices are
based be borne in mind:
Laspeyre's index is based on the assumption that unless there is a
change in tastes and preferences, people continue to buy a fixed
basket of goods irrespective of how high or low the prices are likely
to be in the future. Paasche's index, on the other hand, assumes that

people would have bought the same amount of a given basket of
goods in the past irrespectiveof how high or low were the past prices.
However, the basic contention implied in the assumptions on which
the two indices are based is not true. For, people do make shifts in
their purchase pattern and preferences by buying more of goods that
tend to become cheaper and less of those that tend to become costlier.
In view of this, the following two situations that are likely to emerge
need consideration:
1. When the prices of goods that enter into the construction of these
indices show a general tendency to rise, those whose prices increase
more than the average increase in prices will have smaller quantities
in the given period than the corresponding quantities in the base
period. That is, qi’s will be smaller than q0’s when prices in
general are rising. Consequently, Paasche's index will have relatively
smaller weights
than those in the Laspeyre's index and, therefore, the former ( Pa iP 0
) will be smaller
than the latter ( La iP 0 ). In other words, Paasche's index will show a
relatively smaller
increase when the prices in general tend to rise.
2. On the contrary, when prices in general are falling, goods whose
prices show a relatively smaller fall than the average fall in prices,
will have smaller quantities in the given period than the
corresponding quantities in the base period. This means that qi’s will
be smaller than q0’s when prices in general are falling. Consequently,
Paasche's index will have smaller weights than those in the Laspeyre's
index and, therefore, the former ( Pa iP 0 ) will be smaller than the
latter ( La iP 0 ). In other words, Paasche's index will show a
relatively greater fall when the prices in general tend to fall.
An important inference based on the above discussion is that the
Paasche's index has a downward bias and the Laspeyre's index an
upward bias. This directly follows from the fact that the Paasche's
index, relative to the Laspeyre's index, shows a smaller rise when the
prices in general are rising, and a greater fall when the prices in
general are falling.

It may, however, be noted that when the quantity demanded increases
because of change in real income, tastes and preferences, advertising,
etc., the prices remaining unchanged, the Paasche's index will show a
higher value than the Laspeyre's index. In such situations, the
Paasche's index will overstate, and the Laspeyre's will understate, the
changes in prices. The former now represents the upper limit, and the
latter the lower limit, of the range of price changes.
1. Pa i La i PP 00 = when either rxy , Sx and Sy is equal to zero. That
is, the two indices will
give the same result either when there is no correlation between the
price and quantity movements, or when the price or quantity
movements are in the same ratio so that Sx or Sy is equal to zero.
2. Since in actual practice rxy will have a negative value between 0
and -1, and as neither Sx = 0 nor Sy = 0, the right hand side of Eq. (6-
16) will be less than 1. This means that La iP 0 is normally greater
than Pa iP 0 .
3. Given the overall movement in the index of value ( i V0 )
expanded, the greater the coefficient of correlation (rxy) between
price and quantity movements and/or the greater the degree of
dispersion (Sx and Sy) in the price and quantity movements, the
greater the discrepancy between La iP 0 and Pa iP 0 .
4. The longer the time interval between the two periods to be
compared, the more the chances for price and quantity movements
leading to higher values of Sx and Sy. The assumption of tastes,
habits, and preferences remaining unchanged breaking down over a
longer period, people do find enough time to make shifts in their
consumption pattern, buying more of goods that may have become
relatively cheaper and less of those that may have become relatively
dearer. All this will end up with a higher degree of correlation
between the price and quantity movement. Consequently, La iP 0 will
diverge from Pa iP 0 more in the long run than in the short run.
So long as the periods to be compared are not much apart, La iP 0 will
be quite close to
Pa iP 0 .
Laspeyre’s and Paasche’s Indices Further Considered The use of
different system of weights in these two indices may give an

impression as if they are opposite to each other. Such an impression is
not sound because both serve the same purpose, although they may
give different results when applied to the same data. This raises an
important question. Which one of them gives more accurate results
and which one should be preferred over the other? The answer to this
question is rather difficult since both the indices are amenable to
precise and useful results.
Despite a very useful and precise difference in interpretation, in actual
practice the Laspeyre's index is used more frequently than the
Paasche's index for the simple reason that the latter requires frequent
revision to take into account the yearly changes in weights. No such
revision is required in the case of the Laspeyre's index where once the
weights have been determined, these do not require any change in any
subsequent period. It is on this count that the Laspeyre's index is
preferred over the Paasche's index.
However, this does not render the Paasche's index altogether useless.
In fact, it supplements the practical utility of the Laspeyre's index.
The fact that the Laspeyre's index has an upward bias and the
Paasche's index downward bias, the two provide the range between
which the index can vary between the base period and the given
period. Interestingly, thus, the former represents the upper limit, and
the latter the lower limit.
Improvements over the Laspeyre’s and Paasche’s Indices To
overcome the difficulty of overstatement of changes in prices by the
Laspeyre's index and understatement by the Paasche's index, different
indices have been developed to compromise and improve upon them.
These are particularly useful when the given period and the base
period fall quite apart and result in a greater divergence between
Laspeyre's and Paasche's indices.
Other important Weighted Aggregative Indices are:
1. Marshall-Edgeworth Index The Marshall-Edgeworth Index uses the
average of the base period and given period quantities/prices as the
weights, and is expressed as
INDEX OF WEIGHTED AVERAGE OF PRICE/QUANTITY
RELATIVES An alternative system of assigning weights lies in
using value weights.

TESTS OF ADEQUACY OF INDEX NUMBERS We have
discussed various formulae for the construction of index numbers.
None of the formulae measures the price changes or quantity changes
with perfection and has some bias. The problem is to choose the most
appropriate formula in a given situation. As a measure of the formula
error a number of mathematical tests, known as the tests of
consistency or tests of adequacy of index number formulae have been
suggested. In this section we will discuss these tests, which are also
sometimes termed as the criteria for a good index number.
1. Unit Test: This test requires that the index number formula should
be independent of the units in which the prices or quantities of various
commodities are quoted. All the formulae discussed in the lesson
except the index number based on Simple Aggregate of
Prices/Quantities satisfy this test.
2. Time Reversal Test: The time reversal test, proposed by Prof Irving
Fisher requires the index number formula to possess time consistency
by working both forward and backward w.r.t. time. In his (Fisher’s)
words:
“The formula for calculating an index number should be such that it
gives the same ratio between one point of comparison and the other,
no matter which of the two is taken as the base or putting it another
way, the index number reckoned forward should be reciprocal of the
one reckoned backward.”
In other words, if the index numbers are computed for the same data
relating to two periods by the same formula but with the bases
reversed, then the two index numbers so obtained should be the
reciprocals of each other. Mathematically, we should have (omitting
the factor 100),
1=abba PxP …………(6-29) or more generally
10110 =PxP …………(6-29a) Time reversal test is satisfied by the
following index number formulae:
(i) Marshall-Edgeworth formula
(ii) Fisher’s Ideal formula
(iii) Kelly’s fixed weight formula
(iv) Simple Aggregate index
(v) Simple Geometric Mean of Price Relatives formula

(vi) Weighted Geometric Mean of Price Relatives formula with
fixed weights
Lespeyre’s and Pasche’s index numbers do not satisfy the time
reversal test.
3. Factor Reversal Test: This is the second of the two important tests
of consistency proposed by Prof Irving Fisher. According to him:
“Just as our formula should permit the interchange of two times
without giving inconsistent results, so it ought to permit interchanging
the price and quantities without giving inconsistent results – i.e., the
two results multiplied together should give the true value ratio, except
for a constant of proportionality.” This implies that if the price and
quantity indices are obtained for the same data, same base and current
periods and using the same formula, then their product (without the
factor 100) should give the true value ratio. Symbolically, we should
have (without factor 100).
4. Circular Test: Circular test, first suggested by Westergaard, is an
extension of time reversal test for more than two periods and is based
on the shift ability of the base period. This requires the index to work
in a circular manner and this property enables us to find the index
numbers from period to period without referring back to the original
base each time. For three periods a,b,c, the test requires :
bc xPaPxP bccaab ≠ ≠= 1 …………(6-31)
In the usual notations Eq. (6-31) can be stated as:
1122001 =xPxPP …………(6-31a)
For Instance
1 22 02 11 21 00 10 122101 =≠ ∑ ∑ ∑ ∑ ∑ ∑ pq pq x pq pq x pq pq
.Hence Laspeyre’s index does not satisfy the circular test. In fact,
circular test is not satisfied by any of the weighted aggregative
formulae with changing weights. This test is satisfied only by the
index number formulae based on:
(i) Simple geometric mean of the price relatives, and
(ii) Kelly’s fixed base method
SPECIAL ISSUSES IN THE CONSTRUCTION OF INDEX
NUMBERS 6.8.1 BASE SHIFTING The need for shifting the
base may arise either

(i) when the base period of a given index number series is to be made
more recent, or
(ii) when two index number series with different base periods are to
be compared, or
(iii) when there is need for splicing two overlapping index number
series.
Whatever be the reason, the technique of shifting the base is simple:
100
YearNewBaseNumber of Index Old Current Year of Index Number
Old Number Index Base New x =
Example :Reconstruct the following indices using 1997 as base:
Year : 1991 1992 1993 1994 1995 1996 1997 1998 Index : 100 110
130 150 175 180 200 220
Solution:Shifting the Base Period
Year
Index Number (1991 = 100)
Index Number (1997 = 100)
1991 1992 1993 1994 1995 1996 1997 1998
100 110 130 150 175 180 200 220
(100/200) x100 = 50.00 (110/200) x100 = 55.00 (130/200) x100 =
65.00 (150/200) x100 = 75.00 (175/200) x100 = 87.50 (180/200)
x100 = 90.00 (200/200) x100 = 100.00 (220/200) x100 = 110.00
206
SPLICING TWO OVERLAPPING INDEX NUMBER SERIES
Splicing two index number series means reducing two overlapping
index series with different base periods into a single series either at
the base period of the old series (one with an old base year), or at the
base period of the new series (one with a recent base year). This
actually amounts to changing the weights of one series into the
weights of the other series.
1. Splicing the New Series to Make it Continuous with the Old Series
Here we reduce the new series into the old series after the base year of
the former. splicing here takes place at the base year (1980) of the
new series. To do this, a ratio of the index for 1980 in the old series
(200) to the index of 1980 in the new series (100) is computed and the

index for each of the following years in the new series is multiplied
by this ratio.
(i) Splicing the New Series with the Old Series Year
Price Index (1976 = 100) (Old Series)
Price Index (1980 = 100) (New Series)
Spliced Index Number [New Series x (200/100)]
1976 1977 1978 1979 1980 1981 1982 1983 1984
100 120 146 172 200 -- -- -- --
-- -- -- -- 100 110 116 125 140
100 120 146 172 200 220 232 250 280
2. Splicing the Old Series to Make it Continuous with the New Series
: This means reducing the old series into the new series before the
base period of the letter. As shown in Table 6.8.2(ii), splicing here
takes place at the base period of the new series. To do this, a ratio of
the index of 1980 of the new series (100) to the index of 1980 of the
old series (200) is computed and the index for each of the preceding
years of the old series are then multiplied by this ratio.
CHAIN BASE INDEX NUMBERS The various indices discussed
so far are fixed base indices in the sense that either the base year
quantities/prices (or the given year quantities/prices) are used as
weights. In a dynamic situation where tastes, preferences, and habits
are constantly changing, the weights should be revised on a
continuous basis so that new commodities are included and the old
ones deleted from consideration.
This is all the more necessary in a developing society where new
substitutes keep replacing the old ones, and completely new
commodities are entering the market. To take care of such changes,
the base year should be the most recent, that is, the year immediately
preceding the given year. This means that as we move forward, the
base year should move along the given year in a chain year after year.
Conversion of Fixed-base Index into Chain-base Index
CBIPreviousYear' FBI s Current Year' CBIYear's Current x =
(i) Conversion of Fixed-base Index into Chain-base Index
Year Fixed Base Index Number (FBI)
Conversion Chain Base Index Number (CBI)
1975 1976 1977 1978 1979 1980

376 392 408 380 392 400
-- (392/376) x100 (408/392) x100 (380/408) x100 (392/380) x100
(400/392) x100
100 104.3 104.1 93.1 103.2 102
Conversion of Chain-base Index into Fixed-base Index
PROBLEMS OF CONSTRUCTING INDEX NUMBERS The
above discussion enables us to identify some of the important
problems, which may be faced in the construction of index numbers:
1. Choice of the Base Period: Choice of the base period is a critical
decision because of its importance in the construction of index
numbers. A base period is the reference period for describing and
comparing the changes in prices or quantities in a given period. The
selection of a base year or period does not pose difficult theoretical
questions. To a large extent, the choice of the base year depends on
the objective of the index. A major consideration should be to ensure
that the base year is not an abnormal year. For example, a base period
with very low price/quantity will unduly inflate, while the one with a
very high figure will unduly depress, the entire index number series.
An index number series constructed with any such period as the base
may give very misleading results. It is, therefore, necessary that the
base period be selected carefully.
Another important consideration is that the base year should not be
too remote in the past. A more recent year needs to be selected as the
base year. The use of a particular year for a prolonged period would
distort the changes that it purports to measure. That is why we find
that the base year of major index numbers, such as consumer price
index or index of industrial production, is shifted from time to time.
2. Selection of Weights to be Used: It should be amply clear from
the various indices discussed in the lesson that the choice of the
system of weights, which may be used, is fairly large. Since any
system of weights has its own merits and is capable of giving results
amenable to precise interpretations, the weights used should be
decided keeping in view the purpose for which an index is
constructed.
It is also worthwhile to bear in, mind that the use of any system of
weights should represent the relative importance of individual

commodities that enter into the construction of an index. The
interpretations that are intended to be made from an index number are
also important in deciding the weights. The use of a system of weights
that involves heavy computational work deserves to be avoided.
3. Type of Average to be Used: What type of average should be used
is a problem specific to simple average indices. Theoretically, one can
use any of the several averages that we have, such as mean, median,
mode, harmonic mean, and geometric mean. Besides being locational
averages, median and mode are not the appropriate averages to use
especially where the number of years for which an index is to be
computed, is not large.
While the use of harmonic mean and geometric mean has some
definite merits over mean, particularly when the data to be averaged
refer to ratios, mean is generally more frequently used for
convenience in computations.
4. Choice of Index: The problem of selection of an appropriate index
arises because of availability of different types of indices giving
different results when applied to the same data. Out of the various
indices discussed, the choice should be in favour of one which is
capable of giving more accurate and precise results, and which
provides answer to specific questions for which an index is
constructed. While the Fisher's index may be considered ideal for its
ability to satisfy the tests of adequacy, this too suffers from two
important drawbacks. First, it involves too lengthy computations, and
second, it is not amenable to easy interpretations as are the Laspeyre's
and Paasche's indices. The use of the term ideal does not, however,
mean that it is the best to use under all types of situations. Other
indices are more appropriate under situations where specific answers
are needed.
5. Selection of Commodities: Commodities to be included in the
construction of an index should be carefully selected. Only those
commodities deserve to be included in the construction of an index as
would make it more representative. This, in fact, is a problem of
sampling, for being related to the selection of commodities to be
included in the sample.

In this context, it is important to note that the selection of
commodities must not be based on random sampling. The reason
being that in random sampling every commodity, including those that
are not important and relevant, have equal chance of being selected,
and consequently, the index may not be representative. The choice of
commodities has, therefore, to be deliberate and in keeping with the
relevance and importance of each individual commodity to the
purpose for which the index is constructed.
6. Data Collection: Collection of data through a sample is the most
important issue in the construction of index numbers. The data
collected are the raw material of an index. Data quality is the basic
factor that determines the usefulness of an index. The data have to be
as accurate, reliable, comparable, representative, and adequate, as
possible. The practical utility of an index also depends on how readily
it can be constructed. Therefore, data should be collected from where
these can be easily available. While the purpose of an index number
will indicate what type of data are to be collected, it also determines
the source from where the data can be available.
Time Series Analysis
A series of observations, on a variable, recorded after successive
intervals of time is called a time series. The successive intervals are
usually equal time intervals, e.g., it can be 10 years, a year, a quarter,
a month, a week, a day, and an hour, etc. The data on the population
of India is a time series data where time interval between two
successive figures is 10 years. Similarly figures of national income,
agricultural and industrial production, etc., are available on yearly
basis.
OBJECTIVES OF TIME SERIES ANALYSIS The analysis of
time series implies its decomposition into various factors that affect
the value of its variable in a given period. It is a quantitative and
objective evaluation of the effects of various factors on the activity
under consideration.
There are two main objectives of the analysis of any time series data:
(i) To study the past behaviour of data. (ii) To make forecasts for
future. The study of past behaviour is essential because it provides us
the knowledge of the effects of various forces. This can facilitate the

process of anticipation of future course of events, and, thus,
forecasting the value of the variable as well as planning for future.
Components of a Time Series
long-term tendency of either upward or downward movement in the
average (or mean) value of the forecast variable y over time. The rate
of trend growth usually varies over time, as shown in fig 7.1(a) and
(b). Cycles- An upward and downward oscillation of uncertain
duration and magnitude about the trend line due to seasonal effect
with fairly regular period or long period with irregular swings is
called a cycle. A business cycle may vary in length, usually greater
than one year but less than 5 to 7 years. The movement is through
four phases: from peak (prosperity) to contradiction (recession) to
trough (depression) to expansion (recovery or growth) as shown in
Fig. 7.1 (b) and (c). Seasonal- It is a special case of a cycle
component of time series in which the magnitude and duration of the
cycle do not vary but happen at a regular interval each year. For
example, average sales for a retail store may increase greatly during
festival seasons. Irregular- An irregular or erratic (or residual)
movements in a time series is caused by shortterm unanticipated and
non-recurring factors. These follow no specific pattern.
TIME SERIES DECOMPOSITION MODELS The analysis of
time series consists of two major steps: 1. Identifying the various
forces (influences) or factors which produce the variations in the time
series, and 2. Isolating, analysing and measuring the effect of these
factors separately and independently, by holding other things
constant.
The purpose of decomposition models is to break a time series into its
components: Trend (T), Cyclical (C), Seasonality (S), and Irregularity
(I). Decomposition of time series provides a basis for forecasting.
There are many models by which a time series can be analysed; two
models commonly used for decomposition of a time series are
discussed below.
Multiplicative Model This is a most widely used model which
assumes that forecast (Y) is the product of the four components at a
particular time period. That is, the effect of four components on the
time series is interdependent. Y=T x C x S × I Å Multiplicative

model The multiplicative model is appropriate in situations where the
effect of S, C, and I is measured in relative sense and is not in
absolute sense. The geometric mean of S, C, and I is assumed to be
less than one. For example, let the actual sales for period 20 be Y20 =
423.36. Further let, this value be broken down into its components as:
let trend component (mean sales) be 400; effect of current cycle
(0.90) is to depress sales by 10 per cent; seasonality of the series
(1.20) boosts sales by 20 per cent. Thus besides the random
fluctuation, the expected value of sales for the period is 400 × 0.90 ×
1.20 = 432. If the random factor depresses sales by 2 per cent in this
period, then the actual sales value will be 432 × 0.98 = 423.36. 7.4.2.
Additive Model In this model, it is assumed that the effect of various
components can be estimated by adding the various components of a
time-series. It is stated as: Y=T + C + S + I Å Additive model Here
S, C, and I are absolute quantities and can have positive or negative
values. It is assumed that these four components are independent of
each other. However, in real-life time series data this assumption does
not hold good.
MEASUREMENT OF SECULAR TREND The principal methods
of measuring trend fall into following categories: 1. Free Hand Curve
methods 2. Method of Averages 3. Method of least squares The time
series methods are concerned with taking some observed historical
pattern for some variable and projecting this pattern into the future
using a mathematical formula. These methods do not attempt to
suggest why the variable under study will take some future value.
This limitation of the time series approach is taken care by the
application of a causal method. The causal method tries to identify
factors which influence the variable is some way or cause it to vary in
some predictable manner. The two causal methods, regression
analysis and correlation analysis, have already been discussed
previously. A few time series methods such as freehand curves and
moving averages simply describe the given data values, while other
methods such as semi-average and least squares help to identify a
trend equation to describe the given data values.
Freehand Method A freehand curve drawn smoothly through the
data values is often an easy and, perhaps, adequate representation of

the data. The forecast can be obtained simply by extending the trend
line. A trend line fitted by the freehand method should conform to the
following conditions: (i) The trend line should be smooth- a straight
line or mix of long gradual curves.
(ii) The sum of the vertical deviations of the observations above the
trend line should equal the sum of the vertical deviations of the
observations below the trend line.
(iii) The sum of squares of the vertical deviations of the observations
from the trend line should be as small as possible.
(iv) The trend line should bisect the cycles so that area above the
trend line should be equal to the area below the trend line, not only for
the entire series but as much as possible for each full cycle.
Example: Fit a trend line to the following data by using the freehand
method. Year 1991 1992 1993 1994 1995 1996 1997 1998 Sales
turnover : (Rs. in lakh) 80 90 92 83 94 99 92 104
Solution: Figure 7.2 presents the freehand graph of sales turnover
(Rs. in lakh) from 1991 to 1998. Forecast can be obtained simply by
extending the trend line.
80 85 90 95 100 105 110 1991 1992 1993 1994 1995 1996 1997 1998
Years Sales
Limitations of freehand method
(i) This method is highly subjective because the trend line depends on
personal judgement and therefore what happens to be a good-fit for
one individual may not be so for another.
(ii) The trend line drawn cannot have much value if it is used as a
basis for predictions.
(ii) It is very time-consuming to construct a freehand trend if a
careful and conscientious job is to be done.
Method of Averages The objective of smoothing methods into
smoothen out the random variations due to irregular components of
the time series and thereby provide us with an overall impression of
the pattern of movement in the data over time. In this section, we shall
discuss three smoothing methods. (i) Moving averages (ii) Weighted
moving averages (iii) Semi-averages The data requirements for the
techniques to be discussed in this section are minimal and these
techniques are easy to use and understand. Moving Averages If we

are observing the movement of some variable values over a period of
time and trying to project this movement into the future, then it is
essential to smooth out first the irregular pattern in the historical
values of the variable, and later use this as the basis for a future
projection. This can be done by calculating a series of moving
averages. This method is a subjective method and depends on the
length of the period chosen for calculating moving averages. To
remove the effect of cyclical variations, the period chosen should be
an integer value that corresponds to or is a multiple of the estimated
average length of a cycle in the series. The moving averages which
serve as an estimate of the next period’s
where t = current time period D = actual data which is exchanged
each period n = length of time period In this method, the term
‘moving’ is used because it is obtained by summing and averaging the
values from a given number of periods, each time deleting the oldest
value and adding a new value. The limitation of this method is that it
is highly subjective and dependent on the length of period chosen for
constructing the averages. Moving averages have the following three
limitations: (i) As the size of n (the number of periods averaged)
increases, it smoothens the variations better, but it also makes the
method less sensitive to real changes in the data.
(ii) Moving averages cannot pick-up trends very well. Since these are
averages, it will always stay within past levels and will not predict a
change to either a higher or lower level.
(iii) Moving average requires extensive records of past data. Example
7.2: Using three-yearly moving averages, determine the trend and
short-term-error. Year Production (in ‘000 tonnes) Year Production
(in ‘000 tonnes) 1987 21 1992 22 1988 22 1993 25 1989 23 1994 26
1990 25 1995 27 1991 24 1996 26 Solution: The moving average
calculation for the first 3 years is: 21 + 22 + 23 Moving average (year
1-3) = = 22 3 Similarly, the moving average calculation for the
next 3 years is: 22 + 23 + 25 Moving average (year 2-4) = =
22.33 3 A complete summary of 3-year moving average
calculations is given in Table 7.1 Table 7.1: Calculation of Trend and
Short-term Fluctuations Year Production Y 3-Year Moving Total 3-
yearly Moving Average (Trend values y ˆ Forecast Error (y-y ˆ) 1987

21 - - - 1988 22 66 22.00 0 1989 23 70 23.33 -0.33 1990 25 72 24.00
1.00 1991 24 71 23.67 0.33 1992 22 71 23.67 -1.67 1993 25 73 24.33
0.67
1994 26 78 26.00 0 1995 27 79 26.33 0.67 1996 26 - - - Odd and
Even Number of Years
When the chosen period of length n is an odd number, the moving
average at year i is centred on i, the middle year in the consecutive
sequence of n yearly values used to compute i. For instance with n
=5, MA3(5) is centred on the third year, MA4(5) is centred on the
fourth year…, and MA9(5) is centred on the ninth year.
No moving average can be obtained for the first (n-1)/2 years or the
last (n1/2) year of the series. Thus for a 5-year moving average, we
cannot make computations for the just two years or the last two years
of the series.
When the chosen period of length n is an even numbers, equal parts
can easily be formed and an average of each part is obtained. For
example, if n = 4, then the first moving average M3 (placed at period
3) is an average of the first four data values, and the second moving
average M4 (placed at period 4) is the average of data values 2
through 5). The average of M3 and M4 is placed at period 3 because it
is an average of data values for period 1 through 5. Example 7.3:
Assume a four-yearly cycle and calculate the trend by the method of
moving average from the following data relating to the production of
tea in India. Year Production (million lbs) Year Production (million
lbs) 1987 464 1992 540 1988 515 1993 557 1989 518 1994 571 1990
467 1995 586 1991 502 1996 612 Solution: The first 4-year moving
average is: 464 + 515 + 518+ 467 1964 MA 3(4) = = =
491.00
4 This moving average is centred on the middle value, that is, the
third year of the series. Similarly, 515 + 518 + 467+ 502 2002
MA 4(4) = = = 500.50 4 4 This moving average is
centred on the fourth year of the series. Table 7.2. presents the data
along with the computations of 4-year moving averages. Table 7.2:
Calculation of Trend and Short-term Fluctuations Year Production
(mm lbs) 4-yearly Moving Totals 4-Yearly Moving Average 4-Yearly
Moving Average Centred 1987 464 - - - 1988 515 - - - 1964 491.00

1989 518 495.75 2002 500.50 1990 467 503.62 2027 506.75
1991 502 511.62 2066 516.50 1992 540 529.50 2170 542.50
1993 557 553.00 2254 563.50 1994 571 572.00 2326 581.50 -
1995 586 - - - 1996 612 - - - Weighted Moving Averages In moving
averages, each observation is given equal importance (weight).
However, different values may be assigned to calculate a weighted
average of the most recent n values. Choice of weights is somewhat
arbitrary because there is no set formula to determine them. In most
cases, the most recent observation receives the most weightage, and
the weight decreases for older data values. A weighted moving
average may be expressed mathematically as Σ(Weight for
period n) (Data value in period n) Weighted moving average =
ΣWeights Example 7.4: Vaccum cleaner sales for 12 months is given
below. The owner of the supermarket decides to forecast sales by
weighting the past three months as follows: Weight Applied Month
3 Last month 2 Two months ago 1 Three months ago 6 Month :
1 2 3 4 5 6 7 8 9 10 11 12 Actual sales (in units) : 10 12 13 16 19 23
26 30 28 18 16 14
Semi-Average Method The semi-average method permits us to
estimate the slope and intercept of the trend the quite easily if a linear
function will adequately described the data. The procedure is simply
to divide the data into two parts and compute their respective
arithmetic means. These two points are plotted corresponding to their
midpoint of the class interval covered by the respective part and then
these points are joined by a straight line, which is the required trend
line. The arithmetic mean of the first part is the intercept value, and
the slope is determined by the ratio of the difference in the arithmetic
mean of the number of years between them, that is, the change per
unit time. The resultant is a time series of the form : abx y =+ ˆ . The
y ˆ is the calculated trend value and a and b are the intercept and
slope values respectively. The equation should always be stated
completely with reference to the year where x =0 and a description of
the units of x and y. The semi-average method of developing a trend
equation is relatively easy to commute and may be satisfactory if the
trend is linear. If the data deviate much from linearity, the forecast
will be biased and less reliable.

Example: Fit a trend line to the following data by the method of
semi-average and forecast the sales for the year 2002. Year Sales of
Firm (thousand units) Year Sales of Firm (thousand units) 1993 102
1997 108 1994 105 1998 116 1995 114 1999 112 1996 110
Methods of least square The trend project method fits a trend line to
a series of historical data points and then projects the line into the
future for medium-to-long range forecasts. Several mathematical
trend equations can be developed (such as exponential and quadratic),
depending upon movement of time-series data. Reasons to study
trend: A few reasons to study trends are as follows: 1. The study of
trend allows us to describe a historical pattern so that we may
evaluate the success of previous policy. 2. The study allows us to use
trends as an aid in making intermediate and long-range forecasting
projections in the future. 3. The study of trends helps us to isolate and
then eliminate its influencing effects on the time-series model as a
guide to short-run (one year or less) forecasting of general business
cycle conditions. Linear Trend Model If we decide to develop a linear
trend line by a precise statistical method, we can apply the least
squares method. A least squares line is described in terms of its y-
intercept (the height at which it intercepts the y-axis) and its slope
(the angle of the line). If we can compute the yintercept and slope, we
can express the line with the following equation abx y =+ ˆ where y
ˆ = predicted value of the dependent variable a = y-axis intercept b =
slope of the regression line (or the rate of change in y for a given
change in x) x = independent variable (which is time in this case)
Least squares is one of the most widely used methods of fitting trends
to data because it yields what is mathematically described as a ‘line of
best fit’. This trend line has the properties that (i) the summation of all
vertical deviations about it is zero, that is, Σ(y-y ˆ ) = 0, (ii) the
summation f all vertical deviations squared is a minimum, that is,
Σ(y-y ˆ) is least, and (iii) the line goes through the mean values of
variables x and y.
For linear equations, it is found by the simultaneous solution for a
and b of the two normal equations: Σy = na + bΣx and Σxy = aΣx +
bΣx2 Where the data can be coded so that ∑x = 0, two terms in three
equations drop out and we have Σy = na and Σxy = bΣx2

Coding is easily done with time-series data. For coding the data, we
choose the centre of the time period as x = 0 and have an equal
number of plus and minus periods on each side of the trend line which
sum to zero.
Alternately, we can also find the values of constants a and b for any
regression line as:
b= 22 () nxx xyxyn ∑− ∑− and a = bx y−
Exponential Trend Model
When the given values of dependent variable y from approximately a
geometric progression while the corresponding independent variable x
values form an arithmetic progression, the relationship between
variables x and y is given by an exponential function, and the best
fitting curve is said to describe the exponential trend. Data from the
fields of biology, banking, and economics frequently exhibit such a
trend. For example, growth of bacteria, money accumulating at
compound interest, sales or earnings over a short period, and so on,
follow exponential growth.
The characteristics property of this law is that the rate of growth, that
is, the rate of change of y with respect to x is proportional to the
values of the function. The following function has this property.
y = abcx, a > 0
The letter b is a fixed constant, usually either 10 or e, where a is a
constant to be determined from the data.
To assume that the law of growth will continue is usually
unwarranted, so only short range predictions can be made with any
considerable degree or reliability.
If we take logarithms (with base 10) of both sides of the above
equation, we obtain
Log y = log a + (c log b) x (7.2)
For b =10, log b =1, but for b=e, log b =0.4343 (approx.). In either
case, this equation is of the form y′ = c + dx
Where y′= log y, c = log a, and d = c log b.
Equation (7.2) represents a straight line. A method of fitting an
exponential trend line to a set of observed values of y is to fit a
straight trend line to the logarithms of the y-values.

In order to find out the values of constants a and b in the exponential
function, the two normal equations to be solved are Σ log y = n log a
+ log bΣx Σx log y = log aΣx + log bΣx2 When the data is coded so
that Σx = 0, the two normal equations become
Σ log y = n log a or log a = n 1 Σlog y and Σx log y = log b Σx2 or
log b = 2 log x xy ∑ ∑
Coding is easily done with time-series data by simply designating the
center of the time period as x =0, and have equal number of plus and
minus period on each side which sum to zero.
Changing the Origin and Scale of Equations
When a moving average or trend value is calculated it is assumed to
be centred in the middle of the month (fifteenth day) or the year (July
1). Similarly, the forecast value is assumed to be centred in the middle
of the future period. However, the reference point (origin) can be
shifted, or the units of variables x and y are changed to monthly or
quarterly values it desired. The procedure is as follows:
(i) Shift the origin, simply by adding or subtracting the desired
number of periods fromindependent variable x in the original
forecasting equation.
(ii) Change the time units from annual values to monthly values by
dividing independent variable x by 12.
(iii) Change the y units from annual to monthly values, the entire
right-hand side of the equation must be divided by 12.
SEASONAL VARIATIONS
If the time series data are in terms of annual figures, the seasonal
variations are absent. These variations are likely to be present in data
recorded on quarterly or monthly or weekly or daily or hourly basis.
As discussed earlier, the seasonal variations are of periodic in nature
with period less than or equal to one year. These variations reflect the
annual repetitive pattern of the economic or business activity of any
society. The main objectives of measuring seasonal variations are:
(i) To understand their pattern. (ii) To use them for short-term
forecasting or planning. (iii) To compare the pattern of seasonal
variations of two or more time series in a given period or of the same
series in different periods. (iv) To eliminate the seasonal variations
from the data. This process is known as deseasonalisation of data.

Methods of Measuring Seasonal Variations
The measurement of seasonal variation is done by isolating them
from other components of a time series. There are four methods
commonly used for the measurement of seasonal variations. These
method are: 1. Method of Simple Averages 2. Ratio to Trend Method
3. Ratio to Moving Average Method
Method of Simple Averages
This method is used when the time series variable consists of only the
seasonal and random components. The effect of taking average of
data corresponding to the same period (say 1st quarter of each year) is
to eliminate the effect of random component and thus, the resulting
averages consist of only seasonal component. These averages are then
converted into seasonal indices, as explained in the following
examples.
Merits and Demerits
This is a simple method of measuring seasonal variations which is
based on the unrealistic assumption that the trend and cyclical
variations are absent from the data. However, we shall see later that
this method, being a part of the other methods of measuring seasonal
variations, is very useful.
Ratio to Trend Method
This method is used when cyclical variations are absent from the data,
i.e. the time series variable Y consists of trend, seasonal and random
components.
Using symbols, we can write Y = T.S.R
Various steps in the computation of seasonal indices are:
(i) Obtain the trend values for each month or quarter, etc. by the
method of least squares.
(ii) Divide the original values by the corresponding trend values. This
would eliminate trend values from the data. To get figures in
percentages, the quotients are multiplied by 100.
Thus, we have .100 100...100 SR T SRT T Y ×= ×=
(iii) Finally, the random component is eliminated by the method of
simple averages.
Merits and Demerits

It is an objective method of measuring seasonal variations. However,
it is very complicated and doesn’t work if cyclical variations are
present.
Ratio to Moving Average Method
The ratio to moving average is the most commonly used method of
measuring seasonal variations. This method assumes the presence of
all the four components of a time series. Various steps in the
computation of seasonal indices are as follows:
(i) Compute the moving averages with period equal to the period of
seasonal variations. This would eliminate the seasonal component and
minimise the effect of random component. The resulting moving
averages would consist of trend, cyclical and random components.
(ii) The original values, for each quarter (or month) are divided by the
respective moving average figures and the ratio is expressed as a
percentage, i.e. '' .'. SR TCR TCSR MA Y == , where R´ and R´´
denote the changed random components.
(iii) Finally, the random component R´´ is eliminated by the method
of simple averages.

MBA 2018
SUBJECT NAME:
LEGAL ENVIRONMENT FOR BUSINESS

MBA 202-18 Legal Environment for Business
UNIT-I Introduction to Business Laws:- Business Management and
Jurisprudence; Structure of the Indian Legal Systems: sources of Law.
Law of Contract: Definition, features of a valid contract, offer and
Acceptance, Consideration, Capacity of parties, Free consent,
Legality of Object, Performance and Discharge of Contract, breach of
a contract and its remedies. Meaning and types of agents. Special
Contracts-Laws of Agency; Principal-Agent Problem-Bailment,
Pledge, Guarantee and Indemnity.
UNIT-II Sales of Goods Act- Principles of Sales of Goods- Transfer
of Ownership& Property– Performance of contract.
Unit III Partnership Act: Introduction to Partnership Act, admission
of partner, retirement and death of partner, dissolution of partnership
firm. Negotiable Instrument: Bills of Exchange, Promissory Note,
Cheque and Rules Regarding the Crossing of Cheques, Dishonour of
cheques and liability of banker and drawer.
UNIT-IV Company law: Definition and features of company; concept
of corporate veil; distinction between company and partnership firm;
type of companies, Process of formation and incorporation of
Company, Memorandum of Association and Articles of Association,
Definition, qualification, rights, duties and position of Directors,
Constitution of Board of Directors, Chairman of Board, independent
and executive directors, Introduction to meetings and resolution.

UNIT- 1
Law of contract constitutes the most important branch of commercial
law. All of us enter into some type of a contractC on one day or the
other. The law of contract helps a person to determine whether the
contract in which he is entering is a valid contract or not. It provides
the fundamental principles for other branches of commercial law. The
law of Agency, Sale of Goods Act, Negotiable Instrument Act,
Partnership Act are based on the principles of Contract law. The
Indian Contract Act extends to the whole of India except the state of
Jammu and Kashmir .It came into force on the first day of September
1872.
WHAT IS A CONTRACT?-1
Section 2(h)- An agreement enforceable by law is a contract.
Thus for the formation of a contract there must be
1. an agreement
2. the agreement should be enforceable by law An agreement is
defined as every promise and every set of promises forming the
consideration for each other and a promise is an accepted proposal.
Contract = Agreement + Enforceability at law
a) Agreement:- According to sec 2(e) “ every promise or every set
of promises forming the consideration for each other.”
TYPES OF AGREEMENTS:-
 Enforceable agreements:-These are those agreements in
which the aggrieved party has right to approach court of law.
 Un-enforceable agreements:- These are those agreements in
which the aggrieved party does not have right to approach court of
law.
b) Enforceability at law:- It means that to make an agreement a
contract, it must give rise to a legal obligation
DEFINITION:-
According to Salmond:- “Contract is an agreement creating and
defining obligations between the parties.”
According to Sir William Anson:- “ A legally binding agreement
made between two or more persons by which rights are acquired by
one or more to acts or forbearances on the part of the other or others.”
ESSENTIAL FEATURES OF CONTRACT:-SEC-10

1) OFFER AND ACCEPTANCE:- For the formation of a contract
the process of proposal or offer by one party and the acceptance
thereof by the other is necessary. Offer must be clear and specific and
acceptance must be absolute and unconditional. The person who
makes an offer is called as offeror or promisor or proposer and the
person to whom it is made is called as offeree or promise or propose.
When one person signifies to another his willingness to do or abstain
from doing anything with a view to obtaining the assent of the other
to such act or abstinence, he is said to make a proposal. When the
person to whom the proposal is made signifies his assent thereto, the
proposal is said to be accepted.
2) LAWFUL CONSIDERATION:-. Every contact to be enforceable
at law must be supported by a valid consideration. Consideration
means something in return. It is value paid for a promise or the
inducement, price or motive that causes a party to enter into an
agreement or contract
3) CAPACITY OF PARTIES: The parties to a contract must be
competent enough enter into a contract else it will be a invalid
contract. Following persons are allowed to enter into a contract
a. Major:-Major is a person who attained the age of majority
according to the law to which he is subject
b. Person of sound mind - A person is said to be of sound mind
for the purpose of making a contract, if, at the time when he makes it,
he is capable of understanding it and of forming a rational judgment
as to its effect upon his interests.
c. Person not disqualified by Law:-It means a person who is not
disqualified by law from contracting to which he is subject .
The following persons are therefore incompetent to contract
1. Minors
2. Persons of unsound mind
3. Persons disqualified by law to which they are subject
Example:-A, a money lender advances a loan of Rs.5000/- to B who
is a minor on the date of lending of a loan. At the time of repayment
of loan B denied to return the loan. Held A cannot sue B , since the
contract was void abinitio.

4) FREE CONSENT:-It is an essential element of valid contract. The
consent of the contracting parties should be obtained freely and if not
then it becomes voidable at the option of other party whose consent is
so obtained. Consent is said to be free if it is not caused by
the following:-
 Coercion Consent is said to be caused by coercion when it is
obtained by pressure exerted by either committing or threatening to
commit an act forbidden by the Indian Penal Code or unlawfully
detaining or threatening to detain any property.
 Undue influence :- A contract is said to be induced by "undue
influence" where the relation subsisting between the parties are such
that one of the parties is in a position to dominate the will of the other
and uses that position to obtain an unfair advantage over the other..
 Fraud :- It means and includes the following acts done with the
intention to deceive or to induce a person to enter into a contract. (a)
the suggestion that a fact is true when it is not true and the person
making the suggestion does not believe it to be true (b) active
concealment of a fact by a person who has knowledge or belief of the
fact, (c) promise made without the intention of performing it.
 Misrepresentation :- When a person positively asserts that a
fact is true when his information does not warrant it to be so, though
he believes it to be true, it is misrepresentation. A breach of duty
which brings an advantage to the person committing it by misleading
the other to his prejudice is also a misrepresentation.
Example: A was under an impression that he scored 89.6 percent
marks to an interviewer but in reality he scored 89.4 percent. Here his
motive is not to deceive the interviewer.
 Mistake :- Where both parties to an agreement are under a
mistake as to a matter of fact essential to the agreement, the
agreement is void. An erroneous opinion as the value of the thing,
which forms the subject matter of the agreement, is not deemed as
mistake as to a matter of fact. Unilateral mistake, i.e. the mistake in
the mind of only one party does not affect the validity of the contract.
5) LAWFUL OBJECT:-The purpose for which the contract is being
entered should be lawful. Object will be unlawful if :-
 It is forbidden by law.

 It is of such a nature that if permitted it would defeat the
provision of any other law.
 It is fraudulent
 The court regard it as immoral
 If it is opposed to public policy.
Example: (a) A, B and C enter into an agreement for the division
among them of gains acquired, or- to be acquired, by them by fraud.
The agreement is void, as its object is unlawful.
(b) A promises B to drop a prosecution which he has instituted against
B for robbery, and B promises to restore the value of the things taken.
The agreement is void, as its object is unlawful
6) NOT EXPRESSLY DECLARED TO BE VOID:- There are
certain agreements which law does not permit you to enter. These are
following:-
 Agreement without consideration is void, unless it is in
writing and registered, or it is a promise to compensate for something
done, or is a promise to pay a debt barred by limitation.
 Agreement in restraint of marriage. Every agreement in
restraint of the marriage of any person, other than a minor is void. It is
the policy of law to discourage agreements, which restrain freedom of
marriage. Where a party is restrained from marrying at all, or for
marrying for a fixed period or from marrying a particular person, or
class of persons, the agreement is void.
 Agreement in restraint of trade. Every agreement, by which
one is restrained from exercising a lawful profession, trade or
business of any kind, is to that extent void.
 Agreement in restraint of legal proceedings. Every agreement
by which any party thereto is restricted absolutely from enforcing his
rights under or in respect of any contract, by the usual legal
proceedings in the ordinary tribunals, or which limits the time within
which he may thus enforce his rights is void to that extent.
 Agreements for uncertainty. Agreements the meaning of
which is not certain, or capable of being made certain, are void.
 Agreements by way of wager/ Bet. Agreements by way of
wager are void; and no suit shall be brought for recovering anything
alleged to be won on wager, or entrusted to any person to bide by the
result of any game or other uncertain event on which any wager is
made. (Wager means betting or gambling). However certain prizes for
horseracing are exempted.
Example: A agrees to let her daughter to hire to B for concubinage.
The agreement is void, because it is immoral, though the letting may
not be punishable under the Indian Penal Code.
7) Intention to create legal relations: There can be no contract
unless the parties intend to create legal relations. Domestic
arrangements, such as who will do the washing- up etc, are excluded
because the parties have no intention of creating legal relations
BALFOUR Vs BALFOUR(1919):- Mr. Balfour was transferred to
Ceylon and while he was leaving England he promised to send $30
per month to his wife Mrs. Balfour for her medical treatment and
maintenance. After some time he fails to send the promised amount to
her. Mrs. Balfour filed a suit against him. It was held that it was mere
a domestic agreement which is not enforceable at law.
8) CERTAINITY OF PERFORMANCE:-It means the terms of
contract should be clear and specific and not vague
9) POSSIBILITY OF PERFORMANCE:-It means the contract for
which you are going to enter should be possible to perform it else it
will not be a contract.
Example: A saint said to Amar pay me Rs.500/- and I will put soul to
your dead mother’s body. It is not at all possible.
TYPES OF CONTRACT
A) On the basis of Validity B) On the basis of FormationC) On
the basis of Performance
1)Valid contrac1) Express contracts 1) Executed contracts
2)Void contract 2) Implied contract 2)
Executory contract:-
3)Void agreements 3) Quasi contract a)
Unilateral contract
4)Voidable contracts 4) E.com. contracts b)
Bilateral contract
5)Unenforceable contracts
6)Illegal agreements
(A) ON THE BASIS OF VALIDITY:

 Valid contract: A valid contract is a contract which fulfills
all the essential features of contract act 1872 section 10.
 Void contract :- It is an agreement which was legally
enforceable at the time when entered into contract but later on it
becomes impossible to perform it. For Example:-There is an
agreement between A and B that A will sell his house to B which is
located at Delhi. But later on that house got collapsed because of the
earthquake. Now it is not possible for A to perform his performance.
 Void agreements:- According to section 2(g) “ An
agreement which is not enforceable by law by either of the parties is
void”.
Example:- (a) A agrees to sell to B a specific cargo of goods
supposed to be on its way from England to Bombay. It turns out that,
before the day of the bargain, the ship conveying the cargo had been
cast away and the goods lost. Neither party was aware of the facts.
The agreement is void.
(b) A, being entitled to an estate for the life of B, agrees to sell it to C.
B was dead at the time of the agreement, but both parties were
ignorant of the fact. The agreement is void
 Voidable contracts :- - An agreement which is enforceable
by law at the option of one or more of the parties thereto, but not at
the option of the other or others, is a voidable contract. [section 2(i)].
- When consent is obtained by coercion, undue influence,
misrepresentation , mistake or fraud is voidable at the option of
aggrieved party. Here the element of free consent is missing. For
Example:- Mr A kdnaps daughter of Mr.B and ask him to transfer
his Building into his name else he will kill his daughter. So here
coercion is imposed on Mr.B.
 Unenforceable contracts:- It is that contract which is
otherwise valid but cannot be enforced because of some technical
defect and when that defect is removed it will be enforceable.
 Illegal agreements :. A contract which is either prohibited by
law or otherwise against the policy of law is called as illegal
agreement.
(B) ON THE BASIS OF FOMATION:-

 Express contracts :- Express contracts are those contracts in
which the terms of offer and acceptance are either in written or
spoken words.
 Implied contract :- Implied contracts are those contracts in
which offer and acceptance is not made through written or spoken
words but otherwise. These are the result of the circumstances.
 Quasi contract :- ‘Quasi’ means ‘almost’ or ‘apparently but not
really’ or ‘as if it were’. This term is used when one subject resembles
another in certain characteristics but there are intrinsic differences
between the two. ‘Quasi contract’ is not a ‘contract’. It is an
obligation which law created in absence of any agreement. It is based
on equity. There are certain relations resembling those created by
contract. These are termed as ‘quasi contracts’. These are – (a)
Supply of necessaries (section 68) (b) Payment of lawful dues by
interested person (section 69) (c) Person enjoying benefit of a
gratuitous act (section 70) (d) Finder of goods (section 71) (d) Goods
or anything delivered by mistake or coercion (section 72).
 E.com. contracts:- These are those contracts which are entered
into by the parties by the use of internet. The business transactions are
the result of the electronic mode.
(C) ON THE BASIS OF PERFORMANCE:-
 Executed contracts:- Executed contracts are those contracts in
which both the parties have performed their set of obligations for
which they have entered into a contract. E.g A handed over the car to
B and inturn B made the payment to A.
 Executory contract:- These are those contracts in which both
the parties have yet to make their performances. E.g . A will sell the
car to B on 25th January and B will make the payment on 2ndApril.
 Unilateral contract:- These are those contracts in which one
party has performed his set of obligation and other has yet to perform
it. E.g. The coolie has dropped the luggage into the train and the
person has yet to make the payment.
 Bilateral contract:- This contract is similar to executory
contract in which both parties have yet to perform their performances
on some future date.

DIFFERENCE BETWEEN VOIDABLE CONTRACT AND
VOID AGREEMENTS:-
BASIS OF VOIDABLE VOID
DIFFERENCE CONTRACT AGREEMENTS
Definition It is a contract in which It is a contract which is
the element of free not enforceable by law
consent is missing. Its by either of the parties..
performance depends It is void ab initio.
upon the will of the
person to whom offer is
made.
Legal effects It is valid and It has no legal effects
enforceable till it is from the very beginning
rescinded or repudiated
Curability In voidable contract the Its defects are
defect is curable. incurable.
Right of third parties Third party can acquire Third party cannot
a good title. acquire a good title..
Effect on collateral It does not affect the It do affect the
security collateral transaction. collateral transaction.
DIFFERENCE BETWEEN ILLEGAL AND VOID
AGREEMENTS
BASIS OF ILLEGAL VOID
DIFFERENCE AGREEMENTS AGREEMENTS
Definition A contract which is It is a contract which is
either prohibited by law not enforceable by law
or otherwise against the by either of the parties..
policy of law is called It is void ab initio.
as illegal agreement.
Scope It has narrow scope. It has broader scope.
Punishments Parties to an illegal Parties to an illegal
agreements can be agreements may not be
punished. punished
Effect on collateral Transaction collateral to Transaction collateral to
security the illegal agreements the void agreements
are not enforceable at are enforceable at law.
law.
A contract is the result of the legal agreement between two or more
persons who are competent to contract. A contract is formed when

one party the "offeror " makes an offer which is accepted by the other
party (the "offeree" . An offer is a proposal to form a contract .
Definition:- According to Section 2(a):- :” When one party signifies
his assent to another his willingness to do or to abstain from doing
anything with a view to obtain the assent of the other to sach act or
abstinence he is sais to make a proposal.”
Example:- A offers to sell his car to B for Rs.50000/-. B agrees to
pay for it.. Here a is called as an offeror and B is called as an offeree.
Offeror/proposer/promisor:- The person who makes an proposal to
the other person is called as offeror or proposer or promisor.
Offeree/proposee/promise:- The person to whom an offer is being
made is called as offeree or propose or promise.
TYPES OF OFFER
1. Express offer:- It is an offer in which terms of offer are made
clear to both the parties either in written words or in spoken words.
E.g. A says to B , Will you buy my car for Rs.20000/-.?
2. Implied offer:- It is an offer which is not directly made to the
second party but it is the result of the circumstances. E.g. Punjab
roadways bus moving on the road is an implied offer , anybody who
got in have to pay for it.
3. General offer:- It is that offer which is not made to a specified
person but to a public at large. Anybody can accept a general offer
E.g. Matrimonial advertisement in the newspaper.
4. Specific offer:- It is that type of offer which is made to a
specific person and only he has a right to accept it or reject it. E.g. :-A
says to B will you marry me. Here only B can accept or reject it.
5. Cross offer:- When both the parties speak at a certain subject
matter simultaneously, then whose offer is this cannot be ascertained.
So it is cancelled. E.g. Both A and A speak simultaneously on the fee
that okay rs.25000/- is sufficient. Now whose offer is the said amount
cannot be clear.
6. Counter offer:- Counter offer is the rejection of the original
offer. Once the counter offer is made at that very moment the original
offer looses its significance. E.g. The student went to a teacher
madam what will be the fee for accounts coaching.? The teacher says
Rs.3500/-. The student said madam make it 3000/-. As soon as he

gave that proposal the original offer of the teacher is lapsed. Later on
if the student says okay madam take it rs.3500/- , Teacher can refuse
him and can say to him now the charges are Rs.4000/-The student
cannot bind the teacher to accept Rs.3500/- what the earlier fees was.
LEGAL RULES OF AN OFFER
1. Offer must be communicated:- It is truly said that one cannot
make a offer to oneself. The offer should be communicated to the
person to whom it is made. It is obvious that an promise cannot give
any response to the offer unless it is communicated to him.
Communication is must whether it is a specific offer or a general
offer.
2. Offer may be general or-specific person:- Even though it is
mentioned in the definition of the offer that offer must be made to a
specific person but the court is of the view that it can be made to a
public at large. When offer is made to a specific person then only that
person ot his duly authorized agent has a right to accept it or not.
When it is made to a general public then it can be accepted by any
one.
3. Offer must be made to obtain the assent of another:- An
offer must be made with the motive of obtaining the assent of the
other party. A mere statement of intention to make an offer is not an
offer.
4. Intention to create legal relationship:-An offer must be made
with the intention of creating legal obligation. If there is no such
intention then offer does not becomes a proposal.
5. Offer should be clear and specific:- It means that the terms of
offer should be clear, specific and not vague. If the terms of offer are
not clearly stated then even though accepted it will not create a valid
contract.
6. Different from invitation to offer:- An offer must be
distinguished from mere invitation to offer. Sometimes certain actions
seems to be an offer but actually are not so. Below are mentioned
some examples of it:-
 Catalogues and price lists.
 Display of goods with price tags attached to them.
 Advertisements for tenders and quotations.
 Advertisement of sale of goods by auction.
7. No term the non compliance of which amounts to
acceptance:- An offer should not contain any such term the non
compliance of which amounts to acceptance.
8. It should not be in the form of order:- An offer should be in
the mode of the proposal and not order. Order is imposed on the
promise while offer is just to obtain his or her willingness on the
subject matter of the contract.
9. Counter offer is the rejection of original offer.:- Counter offer is
the rejection of the original offer. Once the counter offer is made at
that very moment the original offer looses its significance.
10 Offer may be express or implied:- It is an offer in which terms of
offer are made clear to both the parties either in written words or in
spoken words. E.g. A says to B , Will you buy my car for Rs.20000/-
.?Implied offer:- It is an offer which is not directly made to the
second party but it is the result of the circumstances. E.g. Punjab
roadways bus moving on the road is an implied offer , anybody who
got in have to pay for it
REVOCATION OF OFFER OR
HOW AN OFFER CAN BE LAPSED?
Revocation means "cancellation". Revocation of an offer means its
withdrawal by the offeror. An offer may be revoked at any time
before the offeree accepts it. Revocation of an offer means after
acceptance will be ineffective. If it to be effective, it must be
communicated before the dispatch of the letter of acceptance. Section
5 lays down "a proposal may be revoked at any time before the
communication of its acceptance as against the proposer".
Modes of revocation:
Section 6 describes various modes of revocation of offer. An offer
may be revoked in any of the following ways;
1. By notice:-
An offer may be revoked by the offeror by giving a notice of
revocation to the other party before it is accepted. Notice of
revocation will take effect only when it comes to the knowledge of
the offeree.
2. By the lapse of time:-

If time is prescribed for acceptance, the offer gets revoked by non-
acceptance within that time. If no time is fixed, the offer lapses by the
expiry of a reasonable time. In a celebrated case, M applied for shares
on 28th June. But shares were allotted on 23rd November. M,
therefore, refused to take the shares. The Court held that M was
entitled to refuse as the offer had lapsed by delay in acceptance.
3.By non fulfillment of a certain condition:-
An offer is revoked when the acceptor fails to fulfill a condition
precedent to the acceptance of the offer.
4. By the death or insanity of the offeror:-
An offer is revoked by the death or insanity of the offeror, if the fact
of his death or insanity of the offeror, if the fact of his death or
insanity comes to the knowledge of the acceptor before acceptance.
Under English Law, death of the offeror revokes an offer even if
acceptance is made in ignorance of the death.
5. By counter-offer:
An offer is revoked if a counter-offer is made to it.
.6.Failure to accept it in a prescribed mode:-
An offer must be accepted according to the mode prescribed. If no
mode is prescribed, the acceptance must be according to some usual
or reasonable mode. If the offer is not accepted according to the
prescribed or usual mode, the offer lapses provided the offeror gives
notice to the offeree within a reasonable time that the acceptance is
not according to the mode prescribed. If the offeror fails to do so, he
is deemed to have accepted the acceptance.
ACCEPTANCE:-
Introduction
Section 2(b) states that “ A proposal when accepted becomes a
promise” and defines ‘ acceptance’ as “ when the person to whom the
proposal is made signifies his assent thereto, the proposal is said to be
accepted.” Thus, ‘ acceptance’ is the manifestation by the offeree of
his assent to the terms of the offer.
Thus there are two essential requirements of a valid acceptance
Firstly the offeree to the offeror should communicate acceptance.
Secondly, acceptance should be absolute and unqualified.

Rules Regarding a valid Acceptance
A valid acceptance must be in conformity with the following rules.
1. Acceptance must be given only by the person to whom the
offer is made. An offer can be accepted only by the person or persons
to whom it is made and with whom it imports an intention to contract.
It cannot be accepted by another person without the consent of the
offeror. The rule of law is clear that “ if you propose to make a
contract with A. then B can’t substitute himself for A without your
consent.” An offer made to a particular person can be validly accepted
by him alone.
2. Acceptance must be absolute and unqualified [sec. 7(1)]. In
order to be ly effective it must be an absolute and unqualified
acceptance of all the terms of the offer. Even the slightest deviation
from the terms of the offer makes the acceptance invalid. In effect a
deviated acceptance is regarded as a counter offer in law.
3. It should be in reasonable mode:, Unless the proposal
prescribes the manner in which it is to be accepted. [sec. 7(2)]. If the
offeror prescribes no mode of acceptance, the acceptances must be
communicated according to some usual and reasonable mode. The
usual modes of communication are by word spoken or written or by
conduct, it is called an implied or tacit acceptance. Implied acceptance
may be given either by doing some required act
If the offeror prescribes a mode of acceptance, the acceptance given
accordingly will no doubt be a valid acceptance, even if the
prescribed mode is funny. Thus, if an offeror prescribes lighting a
match as a mode of acceptance and the offeree accordingly lights the
match, the acceptance is effective and complete. But what happens if
the offeree deviates from the prescribed mode? The answer to this
query is given in section 7(2) itself which states that in cases of
deviated acceptances ‘the proposer may, within a reasonable time
after the acceptance is communication to him, insist that his proposal
shall be accepted in the prescribed manner, and not otherwise; but, if
he fails to do so, he accepts the (deviated) acceptance.”
4. Acceptance must be communicated by the acceptor. For an
acceptance to be made it should be made by the offeree but must also

be communicated by, or with the authority of, the offeree (or
acceptor) to the offeror.
5.. Acceptance must be given within a reasonable time and
before the offer lapses. Acceptance must be given within the
specified time limit, if any, and if no time is stipulated, acceptance
must be given within a reasonable time because an offer cannot be
kept open indefinitely
6. Acceptance must succeed the offer. Acceptance must be
given after receiving the offer. It should not precede the offer. In a
company shares were allotted to a person who had not applied for
them. Subsequently he applied for shares being unaware of the
previous allotment. It was held that the allotment of shares previous to
the application was invalid.
7. Rejected offers can be accepted only, if renewed. Offer once
rejected cannot be accepted again unless a fresh offer is made (Hyde
vs. Wrench).
Every contract should be supported by a valid consideration. It is the
life blood of every contract. It is also used in the sense of quid pro
quo which means something in return.
Every contract to be enforceable at law must be supported by a valid
consideration. Section 10 of the Contract Act provides that an
agreement is a contract if it is made for a lawful consideration and
object. The law enforces only those promises which are made for
consideration. Where one party promises to do something, it must get
something in return. If there is no consideration in the contract then
the contract becomes gratuitous and it is not valid except certain
circumstances.
Definition
According to Pollock,
“Consideration is the price for which the promise of other is bought
and the promise thus given for value is enforceable.”
(iii) A promises to pay B Rs 1,000 at the end of six months, if C, who
owes that sum to B, fails to pay it. B promises to grant time to C
accordingly. Here the promise of each party is the consideration for
the promise of the other party
Essentials of Valid Consideration:-

1. Consideration must move at the desire of the promisor.
In order to constitute consideration the act or abstinance forming the
consideration for the promise must be done at the desire or request of
the promi-sor. Thus acts done or services rendered voluntarily, or at
the desire of the third party, will not amount to valid consideration so
as to support a contract. The logic for this may be found in the worry
and expense to which every one might be subjected, if he were
obliged to pay for services, which he does not need or require.
EXAMPLE:-
A sees B’s house on fire and helps in extinguishing it. He cannot
demand payment for his services because B never asked him to come
for help.
DURGA PRASAD VS BALDEO:-
D had built, at his own expense, a market at the request of the
Collector of the District. The shopkeepers in the market promised to
pay D a commission on the articles sold by them in the market. D
sued the shopkeepers for the commission. Held the promise to pay
commission did not amount to a contract for want of consideration,
because D (the promisee) had constructed the market not at the desire
of the shopkeepers (the promisors) but at the desire of the Collector to
please him.
2. Consideration may move from the promisee or any other
person. The second essential of valid consideration, as contained in
the definition of consideration in Section 2 (d), is that consideration
need not move from the promisee alone but may proceed from a third
person. Thus, as long as there is a consideration for a promise, it is
immaterial who has furnished it. It may move from the promisee or
from any other person. This means that even a stranger to the
consideration can sue on a contract, provided he is a party to the
contract. This is sometimes called as ‘Doctrine of Constructive
Consideration’.
3. Consideration may be past, present or future. The words,
“has done or abstained from doing; or does or has abstained from
doing; or promises to do or to abstain from doing,” used in the
definition of consideration clearly indicate, that the consideration may
consist of either something done. or not done in the past, or done or

not done in the present, or promised to be done or not done in the
future, To put it briefly, consideration may consist of past, present, or
future act or abstinence, Consideration may consist of an act or
abstinence. Consideration may consist of either a positive act or
abstinence i.e. a negative act. Thus, an agreement between B and A,
under which B; on failing to pay the debt amount on the due date to
A; promises to raise the rate of interest from 9 per cent to 12 per cent
in consideration of A promising not to file a suit against him for
another one year, is a valid contract; A’s abstinence being the
consideration for B’s promise.
Past consideration. When something is done or suffered before the
date of the agreement, at the desire of the promisor, it is called ‘past
consideration.’ It must be noted that past consideration is good
consideration only if it is given by the promisee, ‘at the desire of the
promisor.
Present consideration. Consideration, which moves simultaneously
with the promise, is called ‘present consideration’ or ‘executed
consideration’.
Example:- A sells and delivers a book to B, upon B’s promise to pay
for it at a future date. The consideration waiting from A is present or
executed consideration since A has done his act of delivering the book
simultaneously with the promise of B. It should, however, be noted
that it is said to be ‘present consideration’ when at the time of the
agreement it is executed on one side and executory on the other. If
both parties have done their part under the contract, e.g., where A
sells a book to B and B pays its price immediately, it is a case of
executed contract (where nothing remains to be done) and not of
executed or present consideration.
Future consideration. When the consideration on both sides is to
move at a future date, it is called ‘future consideration’ or ‘executory
consideration’. It consists of an exchange of promises and each
promise is a consideration for the” other.
4. Consideration need not be adequate:-It means that
consideration is that it must be ‘something’ to which the law attaches
a value. The consideration need not be adequate to the promise for the
validity of an agreement. The law only insists on the presence of

consideration and not on the adequacy of it. It leaves the people free
to make their own bargains.
5) Consideration must be real:- Though consideration need not be
adequate, it must be of some value in the eye of law, i.e., it must be
real and competent. Where consideration is physically impossible, il,
uncertain or illusory, it is not real and therefore shall not be a valid
consideration.
(i) Physically impossible. A promise to do something which is
physically impossible, e.g., to make a dead man alive or to run at a
speed of 100 kilometers per hour, does not form valid consideration.
(ii) Practically impossible A promise to do something which. is il,
e.g., a promise for il cohabitation, does not amount to good
consideration.
(iii) Uncertain consideration. A promise to do something which is
too vague and uncertain, e.g., a promise to pay such remuneration “as
shall be deemed right,” is no consideration in the eye of law. -
(iv) Illusory consideration Again, an illusory or deceptive
consideration does not amount to a valid consideration.
Consideration is illusory if it consists in a promise to perform a public
duty, or to perform a contract already made with the promisor.
6) Consideration must be lawful:- An agreement is void, if it is
based on unlawful consideration and the following conditions are
fulfilled:-
1. It is forbidden by law.
2. It is fraudulent by nature.
3. I is of such nature that if permitted it would defeat the
provisions of any law.
4. It is against the public policy.
5. It involves injury to the person or property of others.
7) It must be something which the promisor is not already bound
to do:- A promise to do what one is already bound to do, either by
law or under an exsisting contract, is not a good consideration for a
new promise. There will be no deteriment to the promise or benefit to
the promisor over and above their exsisting rights or obligations.

8) It must not be illegal, immoral or opposed to public policy:- An
agreement, the object of which is opposed to public policy is void.
The term ‘public policy’ is not defined in the act.
“Public policy is that principle of law which holds that no subject can
lawfully do that which has a tendency to be injurious to the public or
against the public good”.
The following agreements are against the public policy:-
a. Trading with an alien enemy: Any agreement of trading with an
alien enemy is against public policy as it tends to help the enemy
country.
b. Trafficking in public offices:- An agreement for security of
employment in public services are known as trafficking in public
offices are void. The motive of such agreement must be against public
policy.
c. Marriage brokerage: Agreements to pay money or money’s
worth in consideration of procuring a marriage are known as the
contracts of marriage brokerage. Such agreements are void being
opposed to public policy.
d. Stiffing Criminal Prosecution: It is the rule of law that if a
person commits a crime, he must be punished. Thus, any agreement to
prevent the prosecution of a criminal is opposed to public policy and
thus is void.
“No Consideration, No Contract”
Consideration being one of the essential elements of a valid contract
the general rule is that “an agreement made without consideration is
void. The agreements without consideration are gratuitous
agreements. These are not valid. But there are a few exceptions to the
rule, where an agreement without consideration will be perfectly valid
and binding. These exceptions are as follows:
1. Natural Love and affection:- An agreement made without
consideration is enforceable. If it is:-
(i) Expressed in writing.
(ii) Registered under the law for the time being in force for the
registration of documents
(iii) Is made on account of natural love and affection
(iv) Between parties standing in a near relation to each other.

Thus these are four essential requirements which must be complied
with to enforce an agreement made without consideration, as per
Section 25 (1).
2. Agreement to compensate for past voluntary service (Sec.25
(2)].
A promise made without consideration is also valid, if it is a promise
to compensate, wholly or in part, a person who has already voluntarily
done something for the promisor,’ or done something which the
promisor was compellable to do.
EXAMPLE:-
(a) A finds B’s purse and gives it to him. B promises to give A Rs
50. This is a contract.
(b) A supports B’s infant son. B promises to pay A’s expenses in so
doing. This is a contract. (Note that B was legally bound to support
his infant son).
(c) A rescued B from drowning in the river, and B, appreciating the
service that had been rendered, promises to pay Rs 1,000 to A. There
is a contract between A and B. In order to attract this exception, the
following points should be noted:
3. Agreement to pay a time-barred debt (Sec. 25 (3)]:- Where there
is an agreement, made in writing and signed by the debtor or by his
authorised agent, to pay wholly or in part a debt barred by the law of
limitation, the agreement is valid even though It is not supported by
any consideration. A time barred debt cannot be recovered and
therefore a promise to repay such a debt is without consideration,
hence the importance of the present exception.
But before the exception can apply, it is necessary that:
a. The debt must be such of which the creditor might’ have
enforced payment but for the law for the limitation of suits.
b. There must be an ‘express promise to pay’ a time barred debt as
distinguished from a mere ‘acknowledgement of a liability’ in respect
of a debt. Thus. a debtor’s letter to his creditor, “I owe you Rs. 1,000
on account of my time barred promissory note” is not a contract.
There must be a distinct promise to pay;
c. The promise must be in writing and signed by the debtor or his
agent. An oral promise to pay a time-barred debt is unenforceable.

d. The promisor himself must be liable for the debt. The following
makes it more clear.
5. Contract of agency. Section 185 of the Contract Act lays down
that no consideration is necessary to create an agency.
6. Remission by the promisee, of performance of the promise (Sec.
63). For compromising a due debt, i.e., agreeing to accept less than
what is due, no consideration is necessary. In other words, a creditor
can agree to give up a part of his claim and. there need be no
consideration for such an agreement. Similarly, an agreement to
extend time for performances of a contract need not be supported by
consideration (Sec.63).
7. Contribution to charities. A promise to contribute to charity,
though gratuitous, would be enforceable, if on the faith of the
promised subscription, the promisee takes definite steps in furtherance
of the object and undertakes a liability, to the extent of liability
incurred, not exceeding the promised amount of subscription.
Stranger To Contract Cannot Sue –Doctrine Of Privity Of
Contract
Only parties to contracts should be able to sue to enforce their rights
or claim damages as such. However the doctrine has proven
problematic due to its implications upon contracts made for the
benefit of third parties who are unable to enforce the obligations of
the contracting parties. Privity is the legal term for a close, mutual, or
successive relationship to the same right of property or the power to
enforce a promise or warranty.
Exceptions to the Privity rule:-
In the course of time, the courts have introduced a number of
exceptions in which the rule of privity of contract does not prevent a
person from enforcing a contract, which has been made for his benefit
but without he being a party to it. The different exceptions are as
follows:
Trust or Charge
Marriage settlement, partition or other Family arrangements
Acknowledgement or Estoppel
Covenants running with land
Agency

Assignment
Points discussed in detail:-
(i) Where an express or implied trust is created:- A trust is the
property held and managed by one or more persons for another’s
benefit as in Chinnaya case. In case of a trust, the beneficiary can sue
in his own right to enforce his rights under the trust, though he was
not a party to the contract between the settler and the trustees.
(ii) Family settlement. Where a provision is made in a partition or
family arrangement for maintenance or marriage expenses of female
members; such members, though not parties to the agreement, can sue
on the footing of the arrangement.
(iii) When the defendant constitutes himself, as the agent of the
third party/ Acknowledgement or Estoppel:- Whereby the terms of
a contract a party is required to make a payment to a third person (viz.
while making a part payment), a binding obligation is thereby
incurred towards him.. acknowledgement can be express or implied.
Thus if A receives some money from B to be paid over to C and he
admits of this receipt to C, then C can recover this amount from A
who shall be regarded. as the agent of C
(iv) In case of agency:- Where a contract is entered into by an
agent, the principal can sue on it.
(v) In case of assignment of rights under a contract in favour of
a third party:- either voluntarily or by operation of law, the assignee
can enforce the benefits of the contract, e.g., the assignee of an
insurance policy or the official assignee on the insolvency of a person
can sue on the contract even though originally they were not parties to
it.
(vi) Covenants running with land:- A person who purchases a land
with notice that the owner of the land is bound by certain duties
created by an agreement or covenant affecting the land, shall be
bound by them although he was not a party to the agreement.
CAPACITY OF PARTIES
Capacity of the parties to contract is an essential element of a valid
contract. Section 10 of the act provides that the parties must be
competent to contract.
Definition:-

According to section11,
Every person is competent to contract when he
a. is of the age of majority according to the law to which he is
subject
b. Is of sound mind - A person is said to be of sound mind for the
purpose of making a contract, if, at the time when he makes it, he is
capable of understanding it and of forming a rational judgement as to
its effect upon his interests.
c. is not disqualified from contracting by any law to which he is
subject
Therefore a minor is not competent to contract and an agreement by a
minor is void ab initio. He can not ratify an agreement on attaining
the age of majority and validate the same. (Void ab initio means it has
at no time had any legal validity).
The following persons are therefore incompetent to contract
1. Minors
2. Persons of unsound mind
3. Persons disqualified by law to which they are subject
1.MINOR
According to Indian Majority Act 1875, a minor is one who has not
completed the age of 18 years of age.
EXCEPTIONS:
• Where a guardian of a minor person or property has been
appointed under the Guardian and Ward Act 1890.
• Where the superintendence of a minor’s property is assumed by
the Court of Wards.
EFFECTS OF MINOR AGREEMENT:-
1. An agreement with the minor is void:-
2. No ratification
3. Minor can be a promisee or a beneficiary:-.
4. No estoppel against a minor:- But the minors have no privilege
to cheat others.
5. No insolvency :- A minor is not liable under any contract. Even
for the supplies of necessaries, he is not liable personally. Therefore a
minor can never be adjudged as insolvent.

6. Partnership :- A minor can never be a partner since he can’t be
made liable for the debts if any. But the exceptional case under the
section 30 of the Act specifies that the minor can be the partner only
for sharing the benefits not the losses.
7. Minor can be an agent :-.
8. Surety for a minor is liable :-
9. Minor cant bind parent or guardian :-
10. Minor can’t be a shareholder :-
11. Liability for necessaries:-.
2. UNSOUND MIND
A person is said to be of sound mind for the purpose of making a
contract if, at the time when he makes it, he is capable of
understanding it and of forming a rational judgment as to its
effect upon his interests.
A person who is usually of unsound mind, but occasionally of
sound mind, may make a contract when he is of sound mind.
UNSOUNDNESS OF A PERSON ARISES FROM:-
• IDIOCY:- Any person who is totally insane without the
intervals of saneness and an incapable person, who even can’t
understand the ordinary matters because of lack of development of
brain. The agreement with such a person is void.
• LUNACY OR INSANITY:- It is a disease of the brain. A
lunatic loses the use of his reason due to some mental strain or
disease. A person who is of unsound mind , may make a contract
when he is of sound mind. It further provides that a person who is
usually of unsound mind, but occasionally of sound mind may enter
into contract at that time when he is f sound mind
• DRUNKENNESS:- It is also the state of temporary incapability
of mind of taking any decision due to the intoxication impotence of
mind. Therefore, an agreement by a drunken person is absolutely void
and imperative as against him. But a partial or ordinary drunkenness
is not sufficient to avoid a contract. It must be proved that, at the time
of making contract, the person pleading drunkenness was absolutely
intoxicated.

• HYPNOTISM:- It is also the state of temporary incapability of
understanding any ordinary matter due to the matter of artificially
induced sleep.
• MENTAL DECAY: It is mainly due to the age factor.
3. OTHER PERSONS DISQUALIFIED BY LAW
According to section 11, a person to be competent to contract should
not be disqualified from contracting by any law to which he is subject.
Certain persons, other than minor and a person of unsound mind are
disqualified to make a contract under some other law to which he is
subject to.
• ALIEN ENEMY:- A person not an Indian citizen is said to be
an alien. An alien can be a friend or enemy. A contract entered into
with an alien during peacetime is valid and enforceable. But the
contract entered into with an alien during war time is absolutely void.
Contracts entered into before the declaration of war are either
terminated or suspended for the duration of the war and revived after
the war is over.
• FOREIGN SOVEREIGNS AND EMBASSADORS:- These
persons enjoy the special privilege in the sense that they cannot be
sued in our courts. They have the right to enter into contract but can
claim the privilege of not being sued. In India previous sanction of the
Central government must be obtained in order to sue them.
• INSOLVENTS:- When a debtor is adjudged insolvent, his
assets stand vested in the official receiver or official assignee
appointed by the court. He cannot enter into contracts relating to his
business or property. This disqualification of an insolvent is removed
when he is discharged by the court of his liabilities.
• CONVICT:- A convict while undergoing imprisonment is
debarred by law to enter into contract with anybody else. A contract
also cannot sue on contracts, comes to an end at the expiry of the
period of sentence. A convict can however enters into contract when
he is pardoned by the court.
• CORPORATIONS:- A corporation is an artificial person
recognized by law. It exists only in the eyes of law. It is competent to
enter into contract only through its agents.
FREE CONSENT

It is another essential of a valid contract. Consent means that the
parties must have agreed upon the same sense. For a valid contract it
is necessary that the consent of parties to the contract must be free.
According to section 14 consent is free when it is not obtained by
following
(1) coercion, as defined in section 15, or
(2) undue influence, as defined in section 16, or
(3) fraud, as defined in section 17, or
(4) misrepresentation, as defined in section 18, or
(5) mistake, subject to the provisions of section 20,21, and 22
1) COERCION
Consent is said to be caused by coercion when it is obtained by
pressure exerted by either committing or threatening to commit an act
forbidden by the Indian Penal Code or unlawfully detaining or
threatening to detain any property
Essentials of coercion:-
 There must be clear utterance of threat.
 Threat should be to commit an act forbidden by IPC.
 It must be with the intention to induce the other party to enter
into an agreement.
Effects of coercion:-
1) The contact becomes voidable at the option of the aggrieved
person/party, The aggrieved party/person has two options
a.) may compel the other party for specific performance (if deems fit)
b ) may set aside the contract
2) Section 64if the aggrieved party decides to set aside the contract he
must restore any benefits received by him under such contract
Onus of proof:-
It lies in the person who wants to set aside the contract.
2) Undue influence
Contract is said to be induced by "undue influence" where the relation
subsisting between the parties are such that one of the parties is in a
position to dominate the will of the other and uses that position to
obtain an unfair advantage over the other.
Essentials of undue influence :-

1. Where he holds a real or apparent authority over the other . For
example:_
Relationship between inspector and criminal, master and servant.
2. Where he stands in a fiduciary relationship to the other .It means
a relationship of mutual trust and faith. For example:- father and son,
husband and wife, employer and employee, lawyer and client, doctor
and patient
3. Where the mental capacity is temporarily/ permanent affected
by the reason of age , illness or mental distress.
Effects of undue influence:-
1. It is voidable at the option of the other party whose consent is so
obtained.
2. He must repay or return the benefit received due to such act
Onus of proof:-
It lies in the person who wants to set aside the contract
Pardanashin women:-A pardanashin woman is one who is
completely isolated from the society. She does not have much
connection with the outside world. Special protection is given to such
a women on the ground of their being ignorant about what is
happening around the world. A women will be treated as pardanashin
women if:-
1. She does not understand the contents of the contract.
2. She does not form rational judgment about the contract.
3. She does not judge what are the pros and cons of the
contract.
4. She is not allowed to take the advise from the outside
world.
Unconscionable bargain:- Undue influence is suspected when one
party is in such a position to dominate the will of another and the
contract is apparently unfair .
Example:- A lend a loan of Rs.200/- to B on January 1,2008 a
drunkard on a condition that he will pay Rs.500/- on January 2,2008.
Since the rate of interst is too much , the transaction was held as
unconscionable bargain ..
Difference between coercion and undue influence:
Basis of Coercion Undue-influence
differnce
Consent By threat By dominating will of other
Type of force Physical moral
Party By the contracting or the By the contracting party only
third party
Nature of Criminal liability Not criminal liability
liability
3) Fraud
Means and includes the following acts done with the intention to
deceive or to induce a person to enter into a contract.
(a) the suggestion that a fact is true when it is not true and the person
making the suggestion does not believe it to be true
(b) active concealment of a fact by a person who has knowledge or
belief of the fact,
(c) promise made without the intention of performing it
Elements of fraud:-
1. It must be committed by the party to the contract or his
agent
2. It must be with the intention to deceive the other.
3. Statement must be untrue
4. It must be of material misrepresentation.
5. It must be to induce the third party to enter into a contract
6. The other party must have suffered a loss
Essentials of Fraud:-
1. A false statement or active concealment of material fact
2. Acted upon by the party misled and deceived
3. Committed before the conclusion of the contract
4. With the intention to deceive or induce the other
5. Statement made with the knowledge of falsehood of the statement
6. Statement believed to be true by the other party
7. The aggrieved party must suffer some loss
8. The other must have been deceived by the fraudulent conduct of the
first party
Causes of Fraud
1. False statement about fact
2. Active concealment of fact
3. Promise made without intention to perform

4. Aim to deceive the other
5. Any act or omission
Effects of fraud:-
1. He may rescind the contract
2. He may insist that the contract must be performed and he should
be put into that position which he would have been, if the
representation made had been true
3. Notice of the intention (loss of opinion on account of
affirmation/avoidance, if no notice is served
4. Sue for damages (can sue only in case if the rights are available
i.e.
a. no third party has acquired the rights/possession
b. no affirmation declared, when the fraud came to knowledge
c. parties can be restored to their original position
Loss of right to rescind the contract:-The aggrieved party losses the
right to rescind the contract:-
a. party alleged of fraud could discover the fraud through ordinary
diligence
b. the ignorance of fraud/misrepresentation caused the consent
c. after the information of misrepresentation/fraud no intention was
showed to avoid/accept the contract
Burden of Proof:- It lies on the party claiming/pleading on the
grounds of fraud
Mere silence is not fraud:-A party to a contract is not bound to
disclose the whole truth to the other party .Here caveat emptor is
applicable which means “ let the buyer beware.” The seller is not
bound to tell to the buyer about the defects its products carries which
are easily seeable on the face of the product.. Here silence does not
amounts to fraud.
Silence is fraud:-Silence amounts to fraud in following case:
1. Where it is the duty of the person to speak but he does not. For
example itn the case of insurance it is the duty of the insurer to
disclose all material facts to the insurance company. Contract of
insurance is based on the principle of utmost good faith.
2. Where silence is equivalent to speech. For example:- A said to B
if you keep silent I assume that your horse is of sound mind.

4) Misrepresentation:
When a person positively asserts that a fact is true when his
information does not warrant it to be so, though he believes it to be
true, it is misrepresentation. A breach of duty which brings an
advantage to the person committing it by misleading the other to his
prejudice is also a misrepresentation
Misrepresentation includes:
1. Positive assertion:-Positive assertion means the statement
which you are giving should be true according to you in each and
every aspect.
2. Without the intention to deceive the other:- The statement
you believe it to be true and your intention should not be to deceive
the other person.
3. It must relate to matter of fact:- It means that the statement
which you made relates to the subject matter of the contract.
4. It must be made before finalization of contract:- Whatever
the statement has been made it must be before the finalization of the
contract.
5. It must have actually been acted by the party:- Whatever the
statement being made by you must be relied by the party and the party
must have been acted by it.
6. Either made by the party himself or by his agent:- The
misrepresentation must be made either by the party himself or by by
his duly authorized agent. Example: A was under an impression that
he scored 89.6 percent marks to an interviewer but in reality he scored
89.4 percent. Here his motive is not to deceive the interviewer.
Effects of misrepresentation:-
1. He may rescind the contract
2. He may insist that the contract must be performed and he should
be put into that position which he would have been, if the
representation made had been true
3. Claim for restitution (restitution can be claim but no damages,
the return of the paid amount or the transferred property)
Loss of rights to rescind the contract:-The aggrieved party losses
the right to rescind the contract:-

a. when the consent was given with the knowledge of
misrepresentation
b. third party has acquired rights of the subject matter of contract in
good faith and for value
c. the aggrieved party had the means of discovering the truth with
ordinary diligence
Burden of proof It lies on the party pleading/claiming on the
grounds of misrepresentation
Difference b/w fraud and misrepresentation:-
Basis of Fraud Misrepresentation
difference
Intention Willful intention to deceive the No intention to deceive
other party the other party
Remedies The aggrieved party can rescind The aggrieved party can
the contract and claim damages Claim damages only.
Liabilitiy Criminal Not criminal
5) Mistake
Where both parties to an agreement are under a mistake as to a matter
of fact essential to the agreement, the agreement is void. An erroneous
opinion as the value of the thing, which forms the subject matter of
the agreement, is not deemed as mistake as to a matter of fact.
Unilateral mistake, i.e. the mistake in the mind of only one party does
not affect the validity of the contract
A)Mistake of Fact 1) Bilateral/vital operative mistake (Sec. 20)
(when one or both of the parties are under a mistake as to a matter of
fact, essential to agreement. Void in following conditions
- mistake must be of both parties
- it must be a mistake of fact not of law
- must be about a fact corresponding to contract
Types of bilateral mistakes:
1. regarding the existence of subject matter (the existence of the
subject matter is believed by the both parties, which in fact does not
exist, in this situation no constitution of the contract)
2. regarding the identity of subject matter (if the subject matter is not
identical in the minds of the parties then the contract is void)
3. regarding the quality of the subject matter (constitutes the void
agreement)
4. regarding the quantity of the subject matter (constitutes the void
agreement)
5. regarding the title of the subject matter (selling or leasing such a
property which is not possessed by him, constitutes the void
agreement)
6. regarding the price of the subject matter (constitutes the void
agreement)
7. caused by the third party (mistake caused by the negligence of the
third party, agreement is void)
2) Unilateral mistake (when the mistake is done by one of the
parties, then the agreement is not void, it can be avoided only on the
proven grounds of misrepresentation and fraud)
Types of the unilateral mistakes
a.. As to the nature of the transaction (any innocent mistake done by
either of the parties, the agreement is void)
b..As to the identity of the contracting party (where the identity of the
parties is essential and the identity is having some fault the agreement
is declared void, and if the identity is not essential then the agreement
is valid).
B)Mistake of Law
1. A contract is not voidable because it was caused by a mistake as to
any law in force in India but a mistake as to a law not in force in
India has the same effect as a mistake of fact. Example:- A and B
make a contract grounded on the erroneous belief that a particular
debt is barred by the Indian Law of Limitation: the contract is not
voidable.
2.. Mistake of foreign law (treated as the mistake of fact, sec 21;
mistake of the foreign law is has the same effect as the mistake of
fact)
3. Mistake of private law (treated as a mistake of fact, and is
excusable, thus the contract becomes void.
Literally:The word ‘Legality’ means ‘the state of being
legal’ ‘Object’ means ‘purpose’ and ‘Consideration’ means
‘reason’. So the meaning of legality of object and consideration is the
state of being any reason or purpose legal.

Traditionally:An agreement will not be enforced by the court if its
object or the consideration is unlawful. By the expression “Object of
an Agreement” is meant its purpose on design. The object and the
consideration must both be lawful, otherwise the agreement is
void. The object or consideration of an agreement must be lawful.
In order to make the agreement, a valid contract, for, Section 10 lays
down that all agreements are contracts if made for lawful
consideration and with a lawful object. Section 23 declares what kinds
of consideration and objects are not lawful. If the object or
consideration is unlawful for one or the other of the reasons
mentioned in Section 23, the agreement is illegal and therefore void
(Section 23).
UNLAWFUL CONSIDERATION AND OBJECT
1. If it is forbidden by law-If the consideration or the object of a
contract were forbidden by law, it would be unlawful and hence
unenforceable.
2.If it was permitted, it would defeat the provisions of any law The
consideration of an agreement would be unlawful if it is of such
nature that if permitted, would defeat the provisions of any law.
(Section 23)
3. If it is fraudulent:- An agreement, whose object or consideration
is to fraud others, is unlawful and hence void. Where the object of an
agreement between A and B was to obtain a contract from the
commissariat department for the benefit of court , which could not be
obtained for both of them without practicing fraud on the department,
it was held that the object of the agreement was fraudulent, and that
the agreement was therefore void.
4. If it involves or implies injury to the person or property of
another :-An agreement, the consideration of which is the causing of
an injury to a person or property of another, is void.[Section-23]
Injury means criminal or wrongful harm.
b) A bond, which compels the executant to daily attendance and
manual labor until a certain sum is repaid in a certain month and
penalizes default with overwhelming interest, is unlawful and void.
5. If the court regard it as immoral

6. If the court regards it as ‘opposed to public policy’:-If the court
regards the object or consideration of an agreement as opposed to
public policy, the agreement is void (Section 23).The following
agreements are considered to be against the public policy.
i) Trading with an alien enemy:- All trades with public enemies
without a license from the government are unlawful. It is now fully
established that trading with an alien enemy (i.e. a citizen of the other
country at war with the state) is against public policy in so far as it
tends to aid the economy of the enemy country. Such agreement is
illegal.
ii) Agreements for stifling criminal prosecution: It is well-settled
law that if a person has committed a crime, he must be punished.
Hence any agreement, which seeks to prevent the prosecution of a
guilty party is opposed to public policy and is void, for ‘no one can be
allowed to make a trade of felony’. Agreement for stifling prosecution
cannot be enforced.
iii) Agreement interfering with the course of justice:-An
agreement for the purpose of using improper influence with judges is
void.
iv) Champerty and maintenance:- Maintenance is an agreement
made by a disinterested party for litigation. It is a valid agreement.
Champerty is an agreement made by a person to help a party to
litigation, provided that the party receiving help promises to share the
fruits of the litigation in the event of a favorable decision obtained by
him in the suit..
v) Traffic in Public Offices: Agreements for sale or transfer of
Public Offices or for appointments for Public Offices in consideration
of money are illegal, being opposed to public policy. Such
agreements, if enforced, would lead to inefficiency and corruption in
public life.
vi) Agreements creating an interest opposed to duty: If a person
enters into a contract with a public servant, which to knowledge might
cast upon the public service obligations inconsistent with the public
duty, the agreement is void.
viii) Marriage brokerage agreement:- According to English Law
an agreement to pay brokerage to a person for negotiating a marriage,

is void because it is against public policy. The principal underlying
this rule is that marriages should take place according to the free
choice of parties and such choice should not be interfered with by
third parties acting as brokers.
WITHOUT CONSIDERATION:
As agreement without consideration is void but consideration has
been dispensed within the following cases [Section 25(2)].
1.Registered writing: An agreement made without consideration is
valid if, ‘it is expressed in writing and registered under the law for the
time being in force for the registration of documents, and is made on
account of natural love and affection between parties standing in near
relation to each other. – Section 25(1).
An agreement without consideration is valid under section 25(1) only
if the following requirements are complied with:
i) The agreement is made by a written document.
ii) The document is registered according to the law relating to
registration in force atthe time.
iii) The agreement is made on account of natural love and affectioniv)
The parties to the agreement stand in a near relation to each other.
Examples:-
a) A registered agreement between a Muslim husband and his wife to
pay his earnings to her does not need any consideration.
b) A, for natural love and affection, promises to give his son B,
Rs.1000. A puts his promise in writing and registered it. This is a
contract.
2.Compensation of voluntary services: If a promise were made to
compensate a person who has already voluntarily done something for
the promisor, it would be enforceable although there is only past
consideration. This is an exception to the principle that past
consideration is no consideration [section 25(2)], and it has been dealt
with before.
Examples:-
a) D finds B’s purse and gives it to him. B promises to give D
Rs.50. This is contract.
b) D supports B’s infant son. B promises to pay D’s expenses in so
doing. This is a contract.

3.Promises to pay a time-barred debt: If a promise is made in
writing and signed by the person to be charged, to pay a debt of which
the creditor might have enforced payment but for the law for
limitation for suits, the promise would be considered made with good
consideration.
Example-
D owes B Rs.1000 but the debt is barred by the Limitation Act. D
signs a written promise to pay B Rs.500 on account of the debt. This
is a contract.
AGREEMENT BY WAY OF WAGER
Definition of Wager: A wager is an agreement by mutual promises,
each of them conditional on the happening or not happening of an
unknown event.
Examples:-
i) A contract by A to pay money to B on the happening of a given
event, in consideration of B paying to him money on the event not
happening, is a contract by way of wager.
ii) A share market transaction, in which there is no intention to give
or take delivery of the shares and where the parties intend to deal only
with the differences in prices, is a wagering transaction.
a) Lotteries- A lottery is a game of chance. Therefore an agreement
to buy a ticket for a lottery is wagering agreement. The government
may authorize a lottery. The only effect of such authorization is to
attempt the persons conducting the lottery from criminal prosecution
but it remains a wagering transaction.
b) Cross – word puzzles – In an English case it has been held that a
cross-word puzzle, in which pieces depend upon sameness of the
competitors solution with a previously prepared solution kept with the
editor of a newspaper, is a lottery and therefore a wagering
transaction.
Characteristics of wagering agreements:
1. The consideration for the promise under a wagering agreement is
to pay or get money.
2. The money is payable on the happening or the non-happening of
an event.
3. The agreement depends on a future or uncertain event.

4. The essence of gaming and wagering is that one party is to win
and other loses.
5. In wagering agreement no party has control over the event.
6. Commercial transactions are valid, but to pay price differences in
a wagering agreement is void.
Exceptions-
It has been held that the following transactions are not wagers:
a) Shares: Share market transaction in which there is clear
intention to give and take delivery shares.
b) Games of skill: Prizes and competitions which are games of
skill, e.g., picture puzzles; athletic competitions etc. An agreement to
enter into a wrestling contest, in which the winner was to be rewarded
by the whole of the sale-proceeds of tickets and the failing to appear
on that day would have to forfeit Rs.500 was held not to be a
wagering agreement.
c) A statutory exception: an agreement to contribute to the
payment of prize of the value Rs.500 or upward to the winners of a
horse race is valid. This is statutory exception laid down in section 30
of the Contract Act.
d) Contract of insurance: A contract of insurance is not a wagering
agreement.
e) Badla: Badla transaction are exactly similar to the transaction of
‘conversion’ or ‘carrying over’ in the terminology of the stock
exchanges with regard to dealing in securities. Mere agreement to
engage in speculation on the rise and fall in prices goods is not
necessarily a wagering contract. But in one case this contract was held
void under section 23 of Contract Act because it prohibited forward
contracts by a statute on this subject.
CONTRACT IN RESTRAINT OF LEGAL PROCEEDING AND
IMPOSSIBLE ACTS
CONTRACT IN RESTRAINT OF LEGAL PROCEEDING:
Every agreement by which any party is restricted absolutely from
enforcing his rights under any contract by usual legal proceedings in
the courts is void. However there is an exception to the effect that if
two persons agree that any dispute arising between them shall be

referred to arbitration and only the amount awarded in such
arbitration shall be recoverable, is valid (section28).
IMPOSSIBLE ACTS:
An agreement to do an act impossible in itself is void. – Section 56
Examples-
a) A agrees with B to discover treasure by magic. The agreement is
void.
b) A contracts to marry B, being already married to C, and
forbidden by the law to which he is subject to practice polygamy. The
contract is void. But A must make compensation to B for the loss
caused to her by the non-performance of the promise.
The examples cited above are cases of Pre-contractual Impossibility.
Contracts that become impossible to perform by subsequent event are
called Post-contractual Impossibility.
Performance of a contract
Performance of a contract takes place when the parties to the contract
fulfill their obligation arising under the contact within the time and in
the manner prescribed. It means fulfillment of legal obligations
created by the contract. Section 37 lays down that the parties to a
contract must either perform or offers to perform, their respective
promise unless such promise is dispensed or excused. Performance
may be:-
1.Actual performance:- When a promisor has done what he
promised to do, it is actual performance.e.g.:- A agreed to sell to b a
santro car for Rs.20000. A handed over the car and B made the
payment
2.Attempted or tender performance:- Sometimes it so happens that
the promisor is willing to perform but the promise is not willing to
accept it. This is attempted or tender performance.e.g.:- A and B
entered into contract for the delivery of ten kg rice bag. B went to
deliver it at a contracted place and a contracted time but A refuses to
accept it.
Essentials of a valid tender:-
1) it must be unconditional:-where a tender or offer of
performance is unconditional , the other party is under no obligation

to accept it. A person is not bound to accept a tender of railway
receipt that is made subject to demurrage.
Examples
(a)D a debtor, offers to pay to C , the amount due to him on the
condition that C sells certain shares to him at cost.
(b)tender of a sum less than what is due is not a valid tender.(Bank of
Mysore V.B.D.Naidu.
2) It must be of whole quantity.:- It means that the tender should
be made of the whole quantity and not a part of it. A tender by
installment is invalid unless the contract so provides.
3) It must be made at a proper time and place:-When the
contract so provides that the performance should be made at a proper
time and place the performance should be made at the stipulated time
and place. In case it is not mentioned in the contract , then it should be
made at a place of business and during usual business hours.
Example:-
D owes C Rs.100/- payable on first August and at his registered
office. He offers to pay C on first of July .It is not a valid tender
4) It must be made to the proper person or his duly authorized
agent.:-The tender must be made to the proper person or his duly
authorized agent if it is mentioned in the contract.
5) It may be made to any of the several joint promises.:-A
tender made to one of the several joint promisees will have the same
effect as tender is made to all of them.
6) Reasonable opportunity of inspection.:-( section 38(2)) The
person to whom tender is made must be given reasonable opportunity
of inspection of goods. It means that the promise should be given an
opportunity to inspect the goods regarding its quantity and quality..
The tender of goods is not valid when the goods are packed or locked
in a box and the other party is not allowed to open the packet.
7) It must be in proper form:-tender of money should be in the
current coins. A person is under no compulsion to accept a cheque. A
tender by cheque is valid when the person to whom it is made is
willing to accept it.
Contracts which need not be performed:-
1. When its performance becomes impossible..

2. When the parties to the contract agree to substitute a new
contract for it or rescind or alter it
3. When the person at whose option it is voidable , rescinds it.
4. When it is illegal.
5. When the promise neglects or refuses to afford to the promisor
reasonable facilities for the performance of his promise.
6. When the promise dispenses with or remits , wholly or in part,
the performance of the promise made to him or extends the time for
such performance or accepts any satisfaction.
By whom contracts must be performed:-
1) By the promisor :-(section 40) It is a general rule that a
performance should made by the promisor himself where personal
capacity of the promisor is involved but where personal skill or
capacity is not involved it can be by others also. In the case of death
or disablement a contract will be discharged due to impossibility of
performance where personal capacity is involved.
Example:- A a surgeon promised to operate B’s mother on Monday.
A died on Saturday hence contract becomes impossible to perform.
2) By the agent:- :-(section 40) Where the personal skill is not
required or the promise is such as may be performed by any person,
the promisor may get the promise performed by any duly authorizes
agent.
Example:- A partner may make a valid payment due from a firm in
which he is a partner.
3) By the legal representative ( section 37) In case of death of a
promisor before making performance , his representative becomes
bound by the promise unless personal skill is not essential for the
performance.
Example:- A promise to deliver to B 20 bales of cotton. The bales
can be delivered by A or any other person on his behalf.
4) By a third person:-(section 41) A performance can be done by
the third person if the promise accepts the performance.
By whom performance can be demanded:-
1) By the promisee:-The performance of a contract can be
demanded by the promise himself. A third party has no right to

demand a performance even though it is made for the benefit of third
party.
2) By the legal representative:- In the case of death of the
promise, his legal representative can demand performance.
3) By the third party:-A third party can demand the performance
of a contract in certain cases. In a contract of trust , the beneficiary
may demand the performance.
4) By joint promises:- Where the promise is made favor of two or
more persons jointly, the performance of the promise may be
demanded either:-
a) By all the promisees jointly, or
b) In case of death of any of the joint promisees, by the
representative of the deceased jointly with the surviving promisees, or
c) In case of death of all of the joint promisees , by the
representatives of all of them.
Time and place of performance:-It must be determined by the
agreement between the parties themselves. if not then following rules
will be applicable:-
1) Where no time is specified:- (section 46):-If time is not
mentioned in the contract then it should be performed within
reasonable time. Now what is reasonable time depends upon the
nature of the contract and it varies from the contract to contract.
2) Where time is specified:-(section 47):- Where time and place
is specified in the contract it should be performed within that time and
at a place fixed in the contract and during usual working hours.
3) On application for performance:- (section 48):- Where a
promise is to be performed on a certain day and a promisor does not
undertake to perform it without an application by the promise, it is the
duty of the promise to apply for the performance t a particular place
and within a usual working hours of the business. Proper time and
place depends on circumstances in a particular case.
Example:- A undertakes to deliver a thousand maunds of jute to B on
a fixed day. A must apply to B to appoint a reasonable place for the
purpose of receiving it, and must deliver it to him at such place.
4) Where no place is fixed :- (section 49) :–When a promise is to
be performed without application by the promise and no place is

fixed for the performance it is the duty of the promisor to apply to the
promise to appoint a reasonable place for the performance of the
promise and to perform it at such place.
5) Manner of performance :-(section 50):- The performance of a
promise may be made in any manner or at a place any time which the
promise prescribes.
Time as the essence of the contract:-When in a contract, a party
promise to perform a promise by a specified time, it gives the other
party right to expect that the promise shall be performed by that time.
In other words , time is the essence of the contract means that a
breach of a condition as to the time for the performance will entitle
the innocent party to consider the breach as a repudiation of the
contract.
a) When time is the essence of the contract:-Where time is the
essence of a contract , the parties to the contract has to perform the
performance within the stipulated time , if not then it becomes
voidable at the option of the other party. If time is the essence of the
contract then it should be clearly mentioned in the contract.
b) When time is not the essence of the contract::-Where time is
not the essence of the contract–and the promise fails to perform
within the specified time then pomisee has no right to avoid the
contract.. He has a right to claim compensation from the promisor for
any loss incurred by him because of his non performing on a
stipulated time.
Example:-The lessee of a petrol pump had to apply for the renewal of
lease within a time fixed in the contract. The lessee was late by ten
days in his application for renewal for application. The landlord
refused to renew it.here time is the essence of the contract. ( Caltex
(India) Ltd v .Bhagwan Devi Marodia AIR 1969 sc 409)
c) Acceptance of performance after fixed time:- Where the
promise accepts the performance at any time after the fixed time, the
promise cannot claim compensation for any loss incurred by him for
non performance of the promise unless at the time of such acceptance
he has given notice to the promisor
A contract is said to be discharged when the right and obligations
created by the contract come to an end. It means termination of

contractual relationship between the parties. A contract can be
discharged by any of the following modes:-
Modes of discharge of contract:-
(a) By Performance (Section37,38)
(b) By Agreement (Section 62,63)
(c) By impossibility (Section56)
(d) By lapse of time
(e) By Breach (Section39)
(f) By Operation of law
A) Discharge by Performances:- it is very usual mode of discharge.
When both the parties performed their obligation under a contract,
then it is said to be discharged by the performance it may be:-
1)Actual Performance:- When both the parties have performed their
set of obligations for which they have entered into a contract.e.g.:- A
agreed to sell to b a santro car for Rs.20000. A handed over the car
and B made the payment
2)Attempted performance/tender performance:-It means that
sometimes one party is ready to perform his set of obligation but the
other party refuses to accept that, then it is presumed that performance
have been done by the one party. If performance has been tendered
and the other party refuses to perform, the party making the tender
can sue for breach.
(B) Discharge by agreement or consent:- The parties may
discharge the contact by agreement. They are free from their right and
obligation by an agreement without performing the contract. It is the
following ways.
(1) Novation:- When a new contract is formed to replace an
existing one, it is said to be discharge by novation. It means
substituting a new contract for the existing one. The new contract may
be between the same parties or with some strangers. It should take
place with the consent of all the parties .and all the rights and
obligations under the old contract must have been extinguished.
(b) A owes B 1,000 rupees under a contract. B owes C 1,000 rupees.
B orders A to credit C with 1,000 rupees in his books, but C does not
assent to the arrangement. B still owes C 1,000 rupees, and no new
contract has been entered into.

(2) Alteration: When one or more of the material terms of a contract
are altered by the mutual consent of the parties, the contact as the
original from is discharged. In alteration only terms are altered and
not parties. When the old contract is altered with the consent t of the
parties, its performances need not to be performed.e.g.:- A has to
make payment to B of RS.5000/- on April 5,2009. A said that I will
pay you on April 15,2009 and B accepted it.
(3) Rescission:- ( Section 64):- When the parties to the contract
agreed not to perform the contract and all of them agree to rescind it.
Then contract is said to be discharge by rec rescission. Mutual
consent of all the parties is required to rescind the contract.
(4)Remission: ( Section 63):-It means acceptance of lesser amount
or lesser degree of performance than before It is at the will of the
promisee.
(5)Wavier: It means abandonment of right under a contract. When
one waives off his right under a contract, the other party is releases
from his s obligation. The party can waive off his right without
consideration.
(C) Discharged by impossibility of performances. The contact is
automatically discharged by impossibility of performance..
(1) Impossibility existing at the time of agreement. An agreement
to do an act which is impossible is void. .This is known as Pre
contractual/initial impossibility It may be
(a) Known to the parties. It is called absolute impossibility. It is
called as void abinitio. It is seen at the face of the contract.
(b) Unknown to the parties:- When at the time of making the
contract both the parties are ignorant of the impossibility.
(2) By subsequent impossibility: When the parties enter into a
contract for an act which is possible earlier, but later on that becomes
impossible, then it is know as subsequent impossibility. It is
automatically discharged when an act becomes impossible. It is
because the law does not compel the parties of performing the
impossible. It is in the following manner-
(a) By destructions of subject matter:- when the subject matter is
destroyed for which the parties had entered into a contract without
any fault of any of the party, , it is discharged by impossibility.e.g.:-

A agreed to sell to B a house .But before the date of sale earthquake
results in breaking of the house . So B cannot ask A to sell because
subject matter is no more.
(b) By death/personal incapacity When a contract depend upon
personal skill or quality of the person. e.g.:- A has to operate B’s
mother. But A died before the date of operation. So contract is
discharged due to impossibility.
(c) By change of law :-A contact becomes impossible to perform if
the law of the country changes at the time of making performance.
E.g.:- There was a contract for the import and export of gold. But
government banned import and export of gold .So contract could not
be performed.
(d) By declaration of war:- A contract which was entered before
the commencement of war has to be suspended during the war period.
It may be revived at the end of the war.e.g.:-India and Pakistan enter
into a contract for the import and export of agriculture products. But
when war broke out it has to be suspended.
(e) By non existence of the state of thing:- Where the basis of the
contract was the state of the thing and the .change in the state of the
thing results into discharge of the contract.e.g.:- A agreed to marry B.
But before the final time, B got mad .The contact become void.
Impossibility of performance not an excuse;
Impossibility of performance is not a excuse for non performance
.Ordinarily when a person wants to undertake something, he must do
it. unless it’s performance becomes absolutely impossible .In the
following cases a contact is not discharged on the ground of
impossibility.
(1) Difficulty of performance A contact is not discharged of
difficulty of performance. It is not an excuse.
(2) Commercial difficulty; -The contact can no be discharged; of
commercial difficulty. It may happen that after entering in
the contact, the performance become more expensive or less
profitable than it was expected to be. But still it has to be performed.
(3) Failure of 3rd persons :-Where a contact could not be
performed because of the default of a third person on whose word

the promise relied, it is not discharged. The promise has to fulfill the
contract.
(4) Strikes, lockout and civil disturbances; These events do not
discharge A party from performing a contract unless there is a clause
in the contract that in such cases contract need not to be performed.
(5)Failure of one of the object: - When a contract is formed of
several objects, the failure of one of these object does not discharge
the contract.
Effect of supervening impossibility:-
(1) When the performance of contract becomes impossible or
unlawful, the contract becomes void.
(2) When an agreement is discovered to be void , any person who
has received any advantage under such an agreement is bound to
restore it or to make compensation for it to the person from whom the
received it.
(3) Where the promise to do something which he knew or with
redeemable diligence may be have known and which the promises did
not know to be impossible or unlawful, the promisor must make
compensation to the promisee for any less which the promise retains
though the non performance of the promises .
(D) Discharge by lapse of time :-A contract can be discharge by
lapse of time. Here times means the period of limitation. The
limitation Act 1940 mentioned that a contact should be performed
within a specified period. Such period is called as a period of
limitation. If the contract is not performed within a specified time
then contract is discharged by lapse of time
(E) Discharge by breach of contract: -Where one party fails to
perform their contractual obligations or performance is defective or a
lie is found within a contract, the party at fault is said to have
breached the contract. Breach of contract operation as a discharge of
the conflict. It may be-
(1) Actual Breach :-where the pounce actually referees to perform
his promise e.g.-If a supplier of goods does not deliver on the agreed
delivery date this is actual breach.It can be in any of the following
ways.

a) By refusing performance Where the promisee does not perform
or refuses to perform a promise at the time when performance is due.
b) By making defective performance When the promisee performs
his promise but the other party alleges that it is not a proper
performance as agreed .under a contract.
(2) Anticipatory Breach – A refusal to perform a contract by the
promise before the due date of performance is known as the
anticipating breach of the contract. The refusal is made by the
promissee either through express words or through some act which
clearly indicates that he will not perform the contract on the due date.
F) Discharge by operation of Law—A contract is discharged is
dependently of the wishes of the parties.
(1) By Death –If one of the party to the contract dies and the
performance require personal skill & ability., then it is discharged by
operation of law.
(2) By Merger:-Merger takes place when an inferior right under
a contract merges into a superior right under any other contract. The
contract under which the inferior right is available is discharged
automatically with the formation of the new contract under which
superior right is acquired by the same party.
(3) By insolvency- Where a person is adjudged insolvent he is
discharged from all the liabilities and all the he rights and liabilities
are transferred to the official receiver. ..
(4) By unauthorized alteration of the terms of a written
agreement—Where a party to a contract makes any material
alteration is the contract without the consent of other party, the other
party can avoid the contract. An innocent party can treat a contract as
discharged if the other party materially alters a term (such as quantity
or price) without consent
(5) By rights & liabilities vested is the same parson—
REMEDIES FOR BREACH OF CONTRACT
Breach of contract is a legal concept in which a binding agreement or
bargained-for exchange is not honored by one or more of the parties
to the contract by non-performance or interference of the other party's
performance. It means a party to contact has refused to perform his
respective obligation.

A Breach of contract is of two types:
1) Actual Breach of Contract: Actual breach of contract means
one party has refused to perform his contract on the due date
deliberately or knowingly.
2) Anticipatory Breach of Contract: When Party to contract has
refused to perform his part of the promise before the due date of
performance.
In case of an Anticipatory Breach the aggrieved party has two
options:-
a) He may treat it as actual breach on the same date & claim the
various remedies available under the act or
b) He may decide to wait till the due date comes. If he decides to
wait ,then there can be two consequences of such option:
i) If the defaulter perform his promise then such performance
cannot be rejected by the aggrieved party and
ii) If such performance has become impossible due to some change
in circumstances beyond the control of the defaulter then it would not
be treated as breach of a contract but will be treated as discharge of a
contract by supervening impossibility.
Remedies for Breach of a Contract: The following remedies are
available under the act in case of breach:
(A) Claim for damages: The aggrieved party claim damages from
the defaulter .The following f types of damages can be claimed U/S
73.
1) Ordinary or Simple damages: The aggrieved party can claim for
any loss which he has suffer directly because of such breach or which
is the direct result of such breach. The defendant is liable for all
reasonable foreseeable consequences of such breach ..These are
generally measured on the basis of actual loss occurred.
2) Special Damages: Such damages are claim for any loss which is
the indirect result of such breach or which is remotely connected with
such breach of contract.
3) Exemplary or Vindictive damages: Such damages are
awarded in favor of the aggrieved property not only by way of
compensation for loss suffered but also with a view to punish the

guilty party. Generally such type of damages are not awarded under
law of contract , but following are the two exceptions:
a) When a contract of marriage is broken : In such case the
quantum of damages would depend upon the extent of injury to the
feeling of the party concerned.
b) When a cheque is dishonoured without any reason: The rule
is “smaller is the cheque, greater is the insult of the party and heavier
will be the damages.”
4) Nominal Damages: Such damages are awarded by way of
token or for namesake only.
When either of the aggrieved party has not suffered any loss or the
loss suffered is negligible then court would award same “token
damages” in his favor.of the defaulter. It is the duty of the aggrieved
party to mitigate the loss or to minimize the loss suffered .If any loss
has been suffered by him due to his out negligence or lack of action
,then such losses can be claimed.
5) Liquidated damages & Penalty:-
Liquidated damages means “ a sum fixed in advance to be paid by
the defaulter in case of breach is calculated on the basis of some
genuine pre-estimation .When such sum is not based upon any pre-
estimation is, called “Penalty”. Under English Law such
classifications is made and generally liquidated law are allowed but
not the penalty.
But U/S 74 of Indian Contract Act the court
would not make any such distinction, if the amount so fixed is
reasonable, then it would be allowed in full or it may be reduced by
the court .An increase in rate of interest from the date of default, is by
way of penalty and disallowed by the court.
(B) Suit for Specific Performance: It means the aggrieved party is
not interested in monetary compensation but want that the other party
should perform his promise he made under the contract. Such
performance would be granted by the court if:
a) In the opinion of the court money is not the adequate
compensation for the aggrieved party and
b) the contract is of general character it does not require any
personal skill or involvement of the party.

It would not be granted in such cases as a “contract of marriage” or
“Painting of a picture”.
(C) Suit for an injunction: Injunction is the order of the court
restraining any person from doing a particular act .It is preventive
relief and awarded in case of an anticipatory breach contract.
(D) Suit for Quantum Meruit: “Quantum Meruit” means “payment
in accordance with the proportion of the work done”. The aggrieved
party can claim on the basis of work done in the contract if
a) He has done the work in pursuance of the contract and
b) Such Contract has been discharged by the default of the other
party or it is discovered to be void.
c) Contract must be such , which could be divided in parts.
E)Rescission of the contract: If one part has broken the contract then
the other party can rescind such contract and need not to perform his
part of the contract under Section.75. He is free from all the
obligations of the contract. Under section 75 the aggrieved party can
apply for compensation for any loss suffered due to non fulfillment of
the contract.
Contract of Agency
Agency is a special type of contract. The concept of agency was
developed as one man cannot possibly do every transaction himself.
Hence, he should have opportunity or facility to transact business
through others like an agent. An agent is a connecting link between
Principal and the Third party. He may be competent or incompetent
person but the principal must be a competent person
The principles of contract of agency are –
(a) Excepting matters of a personal nature, what a person can do
himself, he can also do it through agent (e.g. a person cannot marry
through an agent, as it is a matter of personal nature)
(b) A person acting through an agent is acting himself, i.e. act of
agent is act of Principal. Since agency is a contract, all usual
requirements of a valid contract are applicable to agency contract
also, except to the extent excluded in the Act. One important
distinction is that as per section 185, no consideration is necessary to
create an agency.

AGENT :-An “agent” is a person employed to do any act for another
or to represent another in dealings with third persons . [section 182].
PRINCIPAL :-The person for whom such act is done, or who is so
represented, is called the “principal” [section 182].
WHO MAY EMPLOY AGENT - Any person who is of the age of
majority according to the law to which he is subject, and who is of
sound mind, may employ an agent. [section 183]. - - Thus, any person
competent to contract can appoint an agent
WHO MAY BE AN AGENT - As between the principal and third
persons any person may become an agent, but no person who is not of
the age of majority and of sound mind can become an agent, so as to
be responsible to his principal according to the provisions in that
behalf herein contained. [section 184]. - - The significance is that a
Principal can appoint a minor or person of unsound mind as agent. In
such case, the Principal will be responsible to third parties. However,
the agent, who is a minor or of unsound mind, cannot be responsible
to Principal. Thus, Principal will be liable to third parties for acts
done by Agent, but agent will not be responsible to Principal for his
(i.e. Agent’s) acts
CONSIDERATION NOT NECESSARY - No consideration is
necessary to create an agency. [section 185]. Thus, payment of agency
commission is not essential to hold appointment of Agent as valid.
AUTHORITY OF AGENT – An agent can act on behalf of
Principal and can bind the Principal
REMUNERATION TO AGENT - Consideration is not necessary
for creation of agency. However, if there is an agreement, an agent is
entitled to get remuneration as per contract
TYPES OF AGENTS:-
1. Broker:- These are those agents who never takes the
possession of the goods he only acts as a link between the buyer and
the seller and claims his commission when the deal is finalized,.
2. Factor:- Such agents takes the possession of goods on
behalf of and at the risk of his principal .he can exercise general lien
over the goods in his possession.
3. Del-credre agent:- such agents gets some extra
commission also which is called as del credre commission. He is

responsible for the recovery of credit sale. amount which could not be
recovered will be his loss.
4. Auctioneer:-He is one who sells goods by inviting bids
from the general public .Sale is concluded on the fall of the hammer.
DUTIES OF AN AGENT:-
A legally recognized (correctly established) agent has legal
obligations to their principal that impose a high level of trust and
responsibility on the agent. In legal terms this is called a “fiduciary
relationship” and this places certain obligations on the agent
regardless of any contractual obligations that may be imposed on
them. The main obligation an agent has is to act in the principal’s best
interests and to act honestly. Some of the other duties of an agent may
include:
1) Duty to fulfill agency An agent must carry out instructions. If an
agent goes beyond or acts contrary to these instructions, and then
causes loss, they are normally liable to cover that loss.
2) Duty to act in person Unless otherwise agreed, or in an
emergency situation, an agent must perform the agency in person, and
not delegate their work to someone else. In other words, if the agent is
allowed to appoint sub-agents, it should be made clear in the agency
agreement.
3) Duty of care, skill and diligence An agent that is paid for their
work is required to exercise the degree of care, skill and diligence that
is reasonably necessary for the proper performance of their
obligations.
4) Duty to promote the principal’s interests The agent is not
permitted to further their own interests, or those of any other person,
in conflict with your interests. An agent therefore has to avoid any
conflicts of interest, and fully disclose any conflicts to the principal.
5) Confidentiality An agent must keep any information provided by
the principal in confidence, completely confidential. Even after the
end of the agency relationship, an agent is not permitted to use any
confidential information acquired in the course of the agency in
competition with the principal, or to the principal’s detriment.
6) Duty not to profit secretly from the agency.
7) Proper management RIGHTS OF PRINCIPAL –

1. Recover damages from agent if he disregards directions of
Principal :-Agent has to work as per the directions provided to him
by his principal, if he go beyond them or do not work as per the
guidelines provided to him and there is a loss to the principal,
principal will recover it from the agent.
2. Obtain accounts from Agent :-Agent has to submit all the
accounts to the principal within reasonable time else principal can ask
him for it.
3. Recover moneys collected by Agent on behalf of Principal :-
It is the duty of the agent to deposit the entire amount that he collects
on behalf of the principal to him within reasonable time else principal
himself has a right to collect it from him.
4. Obtain details of secret profit made by agent and recover it
from him :-It is the duty of the agent that while performing his duty
he should work only for the principal and do not make any secret
profit out of it. If principal comes to know that agent has made a
secret profit out of any transaction then he can ask him to submit him
the entire details of such a transaction.
5. Forfeit remuneration of Agent if he misconducts the
business:-Principal has a right to forfeit the remuneration of the agent
if he misconducts or manhandled the business of the principal.
DUTIES OF PRINCIPAL –
1. Pay remuneration to agent as agreed :- It is the duty of the
principal to pay the agent his respective remuneration what was
agreed between him and the agent at the time of joining within
stipulated time.
2. Indemnify agent for lawful acts done by him as agent :-It is
the duty of the principal to indemnify the agent for all the lawful acts
done by him while performing his duties.
3. Indemnify Agent for all acts done by him in good faith :- It is
the duty of the principal to indemnify the agent for all the acts done
by him while performing his duties .in good faith.
4. Indemnify agent if he suffers loss due to neglect or lack of
skill of Principal:- It is the duty of the principal to indemnify the
agent for any loss suffered to him by the negligent behavior or the
lack of skill of the principal..

TERMINATION OF AGENCY:-
An agency contract is similar to other contracts in that it can be
terminated by:
A) Acts of the parties, or
B) Operation of law
Once an agency relationship is terminated, the agent can no longer
represent the principal or bind the principal to contracts
A) Termination by Acts of the Parties:-
An agency may be terminated by the following acts of the parties:
1. Mutual agreement:-The principal agency relationship
subsisting between the parties comes to an end when both of them by
mutual consent agrees to it.
2. Lapse of time:- If the principal appointed the agent far a
particular time period ad that time period comes to end, agency
automatically got terminated.
3. Purpose achieved:- If principal appoints an agent for a
particular purpose and when that purpose is achieved, agency got
terminated.
4. By notice of revocation:-The principal may revoke the
authority given by him to his agent by giving him a notice of
revocation. Such revocation may be express or implied. The agent
would not act as an agent from the date of such notice.. However the
principal would compensate the agent for the termination of agency
without a proper notice , if any loss is caused to him.
5. Renunciation by the agent:-The agent has also the right to
renounce his agency business by properly informing the principal. If
he leaves without giving the proper notice then he also have to
compensate the principal for such loss.
B) Termination by Operation of Law:-
An agency is terminated by operation of law, including:
1. Death of the principal or agent:-If the principal or the agent
dies , the agency relationship come to an end. Both should be in
existence on the date of transaction.
2. Insanity of the principal or agent:- If the principal or the agent
becomes of unsound mind, the agency relationship come to an end.
Both should be of sound mind on the date of transaction

3. Bankruptcy of the principal:- If the principal has been
adjudged insolvent or bankrupt, then the agency relationship come to
an end from that very moment.
4. Impossibility of performance:-The subject matter for which
the agent has been appointed if that got destroyed then contract of
agency got terminated because of impossibility of performance.
5. Alien enemy:-If the principal or the agent becomes an alien
enemy , relationship of agent and principal got terminated because
trading with the enemy country is opposed to public policy.
EFFECTS OF TERMINATION:-
Such termination would be effective from the date the principal or the
agent has the knowledge of such termination. But in relation to the
third party it would be effective from the date when a proper notice
has been served on them. Failing that the principal as well as the
agent would remain liable to the third partyunder principal of estoppel
or holding out.
SUB AGENT - A person appointed by an agent to perform some
duty, or the whole of the business relating to his agency. A sub-agent
is generally invested with the same rights, and incurs the same
liabilities in regard to his immediate employers, as if he were the sole
and real principal.
SUBSTITUTE AGENT (Section 194 and 195) :-A substitute agent
is an agent who is appointed by the principal but his name is
suggested by the original agent .He is a full fledge agent who gets his
authority directly from the principal and who is directly accountable
to the principal. .The agent is not liable for the acts of the substitute
agent to the principal. However the original agent is bound to
compensate the principal for any loss caused to him by the substitute
agent if it is proved that the agent was negligent in naming out the a
suitable person.
DIFFERENCE BETWEEN SUB AGENT AND SUBSTITUTE
AGENT:-
SUB AGENT SUBSTITUTE AGENT
He is agent of a agent He is appointed by the Principal but
named by the agent
He is accountable to agent only for his He is directly liable to principal
acts.
He gets his remuneration through the He gets his remuneration through the
agent only. principal only
There is no privity of contract between There is privity of contract between
principal and sub agent principal and sub agent
Original gent is liable to principal for Original gent is not liable to principal
his acts and the acts of the sub agent as for the acts of the substituted agent.
well
DIFFERENCE BETWEEN AGENT AND SERVANT:-

AGENT SERVANT
He represents his principal in He has no such authority to
dealing with the third parties. represent his master.
He gets commission as his He gets wages or salary as his
remuneration. remuneration.

UNIT-2
SALE OF GOODS ACT 1930
.MEANING, FORMATION OF CONTRACT
Sale of Goods Act is one of very old mercantile law. Sale of Goods is
one of the special types of Contract. Initially, this was part of Indian
Contract Act itself in chapter VII (sections 76 to 123). Later these
sections in Contract Act were deleted, and separate Sale of Goods Act
was passed in 1930.It extends to the whole of India except the state of
Jammu and Kashmir.
Contract of sale:-
Section 4 of the Sale of Goods Act define a contact of sale as:-
“Section 4 (1) the sales of goods Act defines a contract of sale of
goods as “A contract where by the seller transfers or agrees to transfer
the property in goods to the buyer for a price
A contract of sale consists of :-
1) Sale:- Where under a contract of sale the property in the goods is
transferred from the seller to the buyer, the contract is called a sale
2) Agreement to sell:- where the transfer of the property in the goods
is to take place at a future time or subject to some condition thereafter
to be fulfilled, the contract is called an agreement to sell. [section
4(3)]. An agreement to sell becomes a sale when the time elapses or
the conditions are fulfilled subject to which the property in the goods
is to be transferred. [section 4(4)]
ESSENTIALS OF CONTRACT OF SALE:-
1 .Two parties to contract - Two parties are required for contract. -
“Buyer” means a person who buys or agrees to buy goods. [section
2(1)]. “Seller” means a person who sells or agrees to sell goods.
[section 2(13)]. A part owner can sale his part to another part-owner.
However, if joint owners distribute property among themselves as per
mutual agreement, it is not ‘sale’ as there are no two parties.
EXCEPTIONS:- Same person can be a buyer and a seller in
following cases:-
1. Sale in execution of a decree
2. Sale by a pawnee
3. Dissolution of partnership firm
4. Auction sale

2.Transfer of ownership - “Property” means the general property in
goods, and not merely a special property. [section 2(11)]. In layman’s
terms ‘property’ means ‘ownership’. ‘General Property’ means ‘full
ownership’. Thus, transfer of ‘general property’ is required to
constitute a sale. If goods are given for hire, lease, hire purchase or
pledge, ‘general property’ is not transferred and hence it is not a
‘sale’.
POSSESSION AND PROPERTY - Note that ‘property’ and
‘possession’ are not synonymous. Transfer of possession does not
mean transfer of property. e.g. - if goods are handed over to
transporter or godown keeper, possession is transferred but ‘property’
remains with owner. Similarly, if goods remain in possession of seller
after sale transaction is over, the ‘possession’ is with seller, but
‘property’ is with buyer.
3.Goods - “Goods” means every kind of movable property other than
actionable claims and money; and includes stock and shares, growing
crops, grass, and things attached to or forming part of the land which
are agreed to be severed before sale or under the contract of sale.
[section 2(7)].
4.Price - “Price” means the money consideration for a sale of goods.
[section 2(10)]. Consideration is required for any contract. However,
in case of contract of sale of goods, the consideration should be
‘price’ i.e. money consideration.
5. Essentials of valid contract:- The Sale of Goods Act is
complimentary to Contract Act. Basic provisions of Contract Act
apply to contract of Sale of Goods also. Basic requirements of
contract i.e. offer and acceptance, legally enforceable agreement,
mutual consent, parties competent to contract, free consent, lawful
object, consideration etc. apply to contract of Sale of Goods also
DIFFERENCE BETWEEN SALE AND AGREEMENT TO
SELL
1. Transfer of property (ownership): - In a ‘sale’ the property in
goods passes to the buyer immediately at the time of making the
contract In ‘an agreement to sell’ there is no transfer of property to
the buyer at the time of the contract.

2. Risk of loss. The general rule is that unless otherwise agreed,
the risk of loss prima facie passes with property (Sec. 26). Thus in
case of sale, if the goods are destroyed the loss falls on the buyer even
though the goods may never have come into his possession because
the property in the goods has already passed to the buyer. On the
other hand, in case of an agreement to sell where the ownership in the
goods is yet to pass from the seller to the buyer, such loss has to be
borne by the seller even though the goods are in the possession of the
buyer
3. Consequences of breach: - In case of sale, if the buyer
wrongfully neglects or refuses to pay the price of the goods, the seller
can sue for the price, even though the goods are still in his possession.
In case of an agreement to sell, if the buyer fails to accept and pay for
the goods, the seller can only sue for damages and not for the price,
even though the goods are in the possession of buyer.
4. Right of resale: - In a sale, the property is with the buyer and as
such the seller (in possession of goods after sale) cannot resell the
goods. If he does so, the subsequent buyer having knowledge of the
previous sale does not acquire a title to the goods. The original buyer
can sue and recover the goods from the third person as owner, and can
also sue the seller for the breach of contract as well as for the tort of
conversion. The right to recover the goods from the third person is,
however, lost if the subsequent buyer had bought them bonafide
without notice of the previous sale (Sec. 30).
5. Insolvency of buyer before he pays for the goods: - In a sale,
if the buyer is adjudged insolvent before he pays for the goods, the
seller, in the absence of a ‘right of lien’ over the goods, must deliver
the goods to the Official Receiver or Assignee. The seller is entitled
only to a ratable dividend for the price of the goods. But in an
agreement to sell, in these circumstances, the seller may refuse to
deliver the goods to the Official Receiver or Assignee unless paid for,
as ownership has not passed to the buyers.
6. Insolvency of seller: - If the buyer has already paid the price In
a sale, if the seller is adjudged insolvent, the buyer is entitled to
recover the goods from the Official Receiver or Assignee, as the
property in the goods rests with the buyer. On the other hand, in an

agreement to sell, if the buyer has already paid the price and the seller
is adjudged insolvent, the buyer can only claim a ratable dividend (as
a creditor) and not the goods because property in them still rests with
the seller
Difference between Sale And Hire-Purchase
1. Ownership:-Ownership is transferred from the seller to the
buyer as soon as the contract is entered into. Ownership is transferred
from the seller to the hire-purchaser only when a certain agreed
number of installments are paid.
2. Position of the buyer:-The position of the buyer is that of the
owner. The position of the hire-purchaser is that of the bailee.
3. Termination of the contract:-The buyer cannot terminate the
contract and as such is bound to pay the price of the goods. The hire-
purchaser has an option to terminate the contract at any stage, and
cannot be forced to pay the further installments.
4. If the buyer makes the payment in installments, the amount
payable by the buyer to the seller is reduced, for the payment made by
the buyer is towards the price of the goods. The installments paid by
the hire-purchaser are regarded as hire charges and not as payment
towards the price of the goods till option to purchase the goods is
exercised
Conditions and warranties
A stipulation in a contract of sale with reference to goods which are
the subject thereof may be a condition or a warranty. [section 12(1)].
A condition is a stipulation essential to the main purpose of the
contract, the breach of which gives rise to a right to treat the contract
as repudiated. [section 12(2)]. A warranty is a stipulation collateral to
the main purpose of the contract, the breach of which gives rise to a
claim for damages but not to a right to reject the goods and treat the
contract as repudiated. [section 12(3)]. Whether a stipulation in a
contract of sale is a condition or a warranty depends in each case on
the construction of the contract. A stipulation may be a condition,
though called a warranty in the contract Section 12(4)

DIFFERENCE BETWEEN CONDITION AND WARRANTY:
Basis of difference Condition Warranty
Importance in It is a stipulation It is collateral to the main
contract essential to the main purpose
purpose
Scope It has wider scope. It has narrow scope.
Option of treatment Breach of condition can Breach of warranty can
be treated as breach of never be treated as breach
warranty of condition
Consequences of The buyer can repudiate The buyer can only claim
breach the contract and can damages
claim damages
IMPLIED CONDITIONS
1) Condition as to title -- In every contract of sale, unless the
circumstances of the contract are such as to show a different intention,
there is an implied condition on the part of the seller, that :
In case of a sale, he has a right to sell the goods, and
In case of an agreement to sell, he will have a right to sell the goods at
the time when the property is to pass.
2.Sale by description.
Where there is a contract for the sale of goods by description there is
an implied condition that the goods shall correspond with the
description; and, if the goods does not correspond to the description
then buyer has a right to return the goods. It is immaterial whether the
buyer has seen the goods or not .
3.Conditions As to Quality or Fitness :-
Where the buyer, expressly or by implication, makes known the seller
the particular purpose for which goods are required, so as to show that
the buyer relies on the seller's skill or judgment and the goods are of a
description which it is in the course of the seller's business to supply
(whether or not as the manufacturer of producer), there is an implied
condition that the goods shall be reasonably fit for such purpose. In
other words, this condition of fitness shall apply, if:
1. The buyer makes known to the seller the particular purpose for
which the goods are required,
2. The buyer relies on the seller's skill or judgment,

3. The goods are of a description which he sellers ordinarily
supplies in the course of his business, and
4. The goods supplied are not reasonably fit for the buyer's
purpose.
4.Sale by sample
1. A contract of sale is a contract for sale by sample where there is
a term in the contract, express or implied, to that effect.
2. In the case of a contract for sale by sample there is an implied
condition -
(a) That the bulk shall correspond with the sample in quality;
(b) that the buyer shall have a reasonable opportunity of comparing
the bulk with the sample;
(c) that the goods shall be free from any defect, rendering them
unmerchantable, which would not be apparent on reasonable
examination of the sample
5.Condition as to Merchantability.
1. Where the goods are bought by description from a seller, who
deals in goods of that description (whether or not as the manufacturer
or producer) there is an implied condition that the goods shall be of
merchantable quality.
2. Merchantable quality ordinarily means that the goods should be
such as would be commercially saleable under the description by
which they are known in the market at their full value
6.Condition as to Wholesomeness
In case of sale of eatable provisions and foodstuff, there is another
implied condition that the goods shall be wholesome. Thus, the
provisions or foodstuff must not only correspond to their description,
but must also be merchantable and wholesome. By 'wholesomeness' it
means that goods must be fit for human consumption.
7. Condition Implied by Custom or Trade Usage
An implied warranty or condition as to quality or fitness for a
particular purpose may be annexed by the usage of trade. In certain
sale contracts, the purpose for which the goods are purchased may be
implied from the conduct of the parties or from the nature or
description of the goods. In such cases, the parties enter into the
contract with reference to those known usage. For instance, if a

person buys a perambulator or a medicine the purpose for which it is
purchased is implied from the thing itself; the buyer need not disclose
the purpose to the seller.
IMPLIED WARRANTIES
1. Free from encumbrances:-
The buyer is entitled to a further warranty that the goods shall be free
from any charge or encumbrance in favor of any third party not
declared or known to buyer before or at the time when the contract is
made. If the buyer is required to discharge the amount of the
encumbrance it shall be a breach of this warranty and the buyer shall
be entitled to damages for the same
2.Quiet possession
In every contract of sale, unless there is a contrary intention, there is
implied warranties that the buyer's shall have and enjoy quiet
possession of the goods. If the buyer's right to possession and
enjoyment of the goods is in any way disturbed as consequences of
the seller's defective title, the buyer may sue the seller for damages for
breach of this warranty
WHEN A CONDITION CAN BE TREATED AS WARRANTY?
(1) Waiver of Condition Where a contract of sale is subject to any
condition to be fulfilled by the seller, the buyer may waive the
condition or elect to treat the breach of the condition as a breach of
warranty and not as a ground for treating the contract as repudiated.
(2) Acceptance of goods by the buyer:- Where a contract of sale is
not severable and the buyer has accepted the goods or part thereof,
the breach of any condition to be fulfilled by the seller can only be
treated as a breach of warranty and not as a ground for rejecting the
goods and treating the contract as repudiated, unless there is a term of
the contract, express or implied, to that effect.
(3) Treating the condition as Warranty:- The buyer may elect to
treat a breach of a condition as a breach of warranty.
Caveat Emptor
The principle termed as ‘caveat emptor’ means ‘buyer be aware’.
Generally, buyer is expected to be careful while purchasing the goods
and seller is not liable for any defects in goods sold by him In other
words, it is not the duty of the seller's duty to point out defects of his

own goods. The buyer must inspect the goods to find out if they will
suit his purpose. there is no implied condition or warranty as to
quality or fitness of goods for any particular purpose. As per section
2(12), “Quality of goods” includes their state or condition.
Goddard v. Hobbs 1878,Pigs were sold "subject to all faults\", and
these pigs, being infected, caused typhoid to other healthy pigs of the
buyer, it was held that the seller was not bound to disclose that the
pigs were unhealthy. The rule of the law being 'Caveat Emptor'. .
Exceptions:-The rule if caveat emptor will not apply in the following
conditions:-
1. Where the seller makes a false representation and buyer relies
on that representation.
2. Where the seller actively conceals a defect in the goods, so that
on a reasonable examination the same could not be discovered;
3. Where the buyer makes known to the seller the purpose for
which he is buying the goods, and the seller happens to be a person
whose business is to sell goods of that description, then there is an
implied condition that the goods shall be reasonably fit for such
purpose.
4. In case of sale by description, there is implied condition as to
their being of merchantable quality. However, if the buyer has
examined the goods, this condition of\"merchantability\" extends only
to hidden or latent defects. The defects, which such examination
ought to have revealed, are not covered, i.e., the rule of Caveat
Emptor will be applicable
3. TRANSFER OF Property and possession
Transfer of property as between seller and buyer - Transfer of
general property is required in a sale. ‘Property’ means legal
ownership. It is necessary to decide whether property in goods has
transferred to buyer to determine rights and liabilities of buyer and
seller. Generally, risk accompanies property in goods i.e. when
property in goods passes, risk also passes. If property in goods has
already passed on to buyer, seller cannot stop delivery of goods even
if in the meanwhile buyer has become insolvent. Where there is a
contract for the sale of unascertained goods, no property in the goods

is transferred to the buyer unless and until the goods are ascertained.
[section 18].
Property passes when intended to pass - Where there is a contract
for the sale of specific or ascertained goods the property in them is
transferred to the buyer at such time as the parties to the contract
intend it to be transferred. [section 19(1)]. For the purpose of
ascertaining the intention of the parties regard shall be had to the
terms of the contract, the conduct of the parties and the circumstances
of the case. [section 19(2)]. Unless a different intention appears, the
rules contained in sections 20 to 24 are rules for ascertaining the
intention of the parties as to the time at which the property in the
goods is to pass to the buyer. [section 19(3)].
Specific goods in a deliverable state - Where there is an
unconditional contract for the sale of specific goods in a deliverable
state, the property in the goods passes to the buyer when the contract
is made, and it is immaterial whether the time of payment of the price
or the time of delivery of the goods, or both, is postponed. [section
20].
TRANSFER OF OWNERSHIP
The general rule is that only the owner of goods can transfer a good.
No one can give a better title than he himself has. This rule is
expressed by the maxim "Nemo dat quit non habet" which means"that
no one can give what he has not got. If the seller, therefore, has no
title, or give what he himself has not" defective title, the buyer's title
will be equally wanting or defective as the case may be, though he
may be a purchaser - bonafide and for value.
Faruquaharson v. King (1902)
A finds a ring of B and sells it to a third person who purchases it for
value and in good faith. The true owner, i.e., B can recover from that
person, for A having no title could pass none the better. [
Exceptions to the Rule
1. Sale by Mercantile Agent (Sec.27):- A mercantile agent is one
who, has authority as an agent either to sell the goods, or consign for
the purpose of sale or buy goods or raise money on the security of the
goods.

2. Sale by a Joint-owner (Sec.28):- If one of the several joint
owners, who is in sole possession of the goods by the permission of
the other co owners sells the goods, a buyer who in good faith
purchases the particular goods, gets a good title.
3. Sale by a Person in Possession under a Voidable Contract
(Sec.29):- When the seller of goods has obtained their possession
under a voidable contract which at the time of the contract has not yet
rescinded can transfer a good title to the buyer who buys in good
faith.
4. Sale by the Seller in Possession of Goods after Sale (Sec.30(1))-
Where a seller having sold goods, continues in possession thereof or
of documents or title to the goods, such seller will pass a good title to
the (second) buyer, if that buyer has acted in good faith and without
notice of the previous sale.
5.Sale by an unpaid seller - A seller who has exercised his right of
lien or stoppage in transit can, resell the goods and convey a valid title
to another buyer, though no notice of re-sale has been given to the
original buyer.
6. Sale under the implied authority of the owner or title by
estoppel:-
.7. Sale by finder of lost goods:-Section 169 of Indian Contract Act
1872 empowers the finder of the lost goods to sell the goods even
though he is not a true owner of that good. He can sell the good if it is
of perishable nature or the amount spent by him in tracing the true
owner amounts to two third of the value of the good.
8. Sale by pawnee or pledgee:- Section 176 of Indian Contract Act
1872a pawnee or a pledgee has a power to sell the goods pledged with
him under certain conditions and the buyer acquires a better tile than
he himself has.
9. Sale by auctioner:-In an auction the official receiver sells the
goods by bidding and whosoever pay the highest bid gets the
ownership of that good. Here even though auctioner or the official
receiver is not the true owner still the buyer has got the good title.
Auction sale
Auction sale is special mode of sale. The sale is made in open after
making public announcement. Buyers assemble and make offers on

the spot. Person offering to pay highest price gets the goods. Usually,
auctioneer is appointed to conduct auction. Higher and higher bids are
offered and sale is complete when auctioneer accepts a bid
. In the case of a sale by auction— (Section 64) rules apply
1.When the goods are put up for sale in lots, each lot is deemed, prima
facie, to be the subject matter of a separate contract of sale;
2. At an auction, the sale is complete when the auctioneer announces
its completion by the fall of the hammer or in other customary
manner; until such completion any bidder may withdraw his bid.
3. A right to bid may be reserved expressly by or on behalf of the
seller and where such right is expressly so reserved, but not otherwise,
the seller or any person on his behalf may bid at the auction;
4. RIGHTS OF AN UNPAID SELLER
"Unpaid seller" defined. - (1) The seller of goods is deemed to be

an "unpaid seller" within the meaning of this Act -
(a) when the whole of the price has not been paid or tendered;
(b) when a bill of exchange or other negotiable instrument has been
received as conditional payment, and the condition on which it was
received has not been fulfilled by reason of the dishonor of the
instrument or otherwise.
RIGHTS OF AN UNPAID SELLER
A) AGAINST THE GOODS:-
1) Where the property in the goods has passed to the buyer.
i.Right of Lien -- 'Lien is the right to retain possession of goods until
certain charges in respect thereof are paid. An unpaid seller who is in
possession of the goods is entitled to retain them until payment of the
price, where –
a)The goods have been sold without any stipulation as to credit;
b) The goods have been sold on credit, but the term of credit has
expired or
c) The buyer becomes insolvent.
Where the goods have been sold on credit, the right of lien shall
remain suspended over the period of credit and shall revive on the
expiry of that period.

The right of lien is linked with possession of the goods and not with
the title. It is not affected even if the seller has transferred the
documents of title till he remains in possession of the goods.
However, if the buyer has further transferred the documents of title to
a bona fide purchaser the seller's lien is defeated.
Termination of lien
The unpaid seller of goods loses his lien thereon -
(a)when he delivers the goods to a carrier or other bailee for the
purpose of transmission to the buyer without reserving the right of
disposal of the goods;
(b) When the buyer or his agent lawfully obtains possession of the
goods;
(c) By waiver thereof.
(d) Where the buyer tendered the price.
ii.Right of Stoppage in transit --The right of stoppage of goods in
transit, arises to an unpaid seller after he has parted with the
possession of the goods. The seller has the right to resume possession
of the goods while they are in the course of transit and to retain them
until payment or tender of the price.
The right of stoppage in transit is available to an unpaid seller, when
the buyer becomes insolvent and the goods are in transit.
The buyer is said to be 'insolvent' when he has ceased to pay his debts
in the ordinary course of business, or cannot pay his debts as they
becomes due whether he has committed an act of insolvency or not.
Duration of transit
(1) Goods are deemed to be in course of transit from the time when
they are delivered to a carrier or other bailee for the purpose of
transmission to the buyer, until the buyer or his agent in that behalf
takes delivery of them from such carrier or other bailee.
(2) If the buyer or his agent in that behalf obtains delivery of the
goods before their arrival at the appointed destination, the transit is at
an end
(3) If, after the arrival of the goods at the appointed destination, the
carrier or other bailee acknowledges to the buyer or his agent that he
holds the goods on his behalf and continues in possession of them as
bailee for the buyer or his agent, the transit is at an end it is

immaterial that a further destination for the goods may have been
indicated by the buyer.
(4) If the goods are rejected by the buyer and the carrier or other
bailee continues in possession of them, the transit is not deemed to be
at an end, even if the seller has refused to receive them back
(5) When goods are delivered to a ship chartered by the buyer, it is a
question depending on the circumstances of the particular case,
whether they are in the possession of the master as a carrier or as
agent of the buyer.
(6) Where the carrier or other bailee wrongfully refuses to deliver the
goods to the buyer or his agent in that behalf, the transit is deemed to
be at an end.
(7) Where part delivery of the goods has been made to the buyer or
his agent in that behalf, the remainder of the goods may be stopped in
transit, unless such part delivery has been given in such circumstances
as to show an agreement
How stoppage in transit is effected. –
(1) The unpaid seller may exercise his right of stoppage in transit
either by taking actual possession of the goods, or by giving notice of
his claim to the carrier of other bailee in whose possession the goods
are. Such notice may be given either to the person in actual possession
of the goods or to his principal. In the later case the notice, to be
effectual, shall be given at such time and in such circumstances that
the principal, by the exercise of reasonable diligence, may
communicate it to his servant or agent in time to prevent a delivery to
the buyer
(2) When notice of stoppage in transit is given by the seller to the
carrier or other bailee in possession of the goods, he shall re-deliver
the goods to or according to the directions of the seller. The expenses
of such re-delivery shall be borne by the seller.
iii.Right of Resale -- The rights of lien and stoppage in transit, would
not have been of much value if he seller had no right to resell the
goods, because the seller cannot continue to hold the goods
indefinitely. Section 54 provides an unpaid seller with a limited right
to resell the goods.
An unpaid seller may resell the goods –.

1) When the goods are of perishable nature, the seller can resale it
without giving any notice without giving any notice to the buyer
2) In case of other goods, when after giving a notice to the buyer of
his intention to resell the goods, the buyer does not pay the price
within a reasonable time; and
3) Where the seller has expressly reserved the right of resale in the
contract. No notice to the buyer is required in that case.
4) In case of finder of lost goods the finder can resale it after he has
tried his hard to locate the original owher.
In any of the above case if at the time of resale the goods have been
sold at the lower price than before then whatever the loss , the seller
can recover it from the buyer. But if there is profit it will be of the
seller.
2) Where the property in the goods has not passed to the buyer
Right of withholding Delivery -- Where the property in the goods
has not passed to the buyer, the unpaid seller has the right to withhold
delivery of the goods, which is similar to and co-extensive with his
rights of lien and stoppage in transit which he would have had if the
property had passed.
B) Rights Against the Buyer Personally (Seller's Remedies Against
buyer for Breach of Contract)-- Besides, the above rights against the
goods, an unpaid seller has certain rights against the buyer personally.
The seller enjoys the following rights in personam (also known as
remedies for breach of contract).
1. Suit for Price -- When the property in the goods has passed to
the buyer, and the buyer wrongfully neglects or refuses to pay the
price, the seller is entitled to sue him for the price.
Where under a contract of sale the price is payable on a certain day
irrespective of delivery or passing of property, and the buyer refuses
or neglects to pay on that day, the seller may sue him for the price.
2. Suit for Damages for Non-Acceptance -- Where the buyer
wrongfully neglects or refuses to pay for the goods, the seller may sue
him for damages for non-acceptance.
3. Suit for Damages for Repudiation of contract before date of
delivery Where the buyer repudiates the contract before the date of

delivery, the seller may adopt any of the following two courses of
action, viz.-
a) The seller may treat the contact as rescinded and sue the buyer
for damages. This is also known as 'damages for anticipatory breach'.
The damages will be assessed according to the prices prevailing on
the date of breach.
b) The seller may treat the contract as subsisting and wait till the date
of delivery. The contract remains open at the risk and for the benefit
of both the parties. If the buyer subsequently chooses to perform there
shall be no damages; otherwise he shall be liable to damages assessed
according to the prices on the day stipulated for delivery.
4. Suit for Interest --The seller may recover interest or special
damages whereby law interest or special damages may be
recoverable.
DIFFERENCE BETWEEN RIGHT OF LIEN AND RIGHT OF
STOPPAGE IN TRANSIT:-
Basis of Right of lien Right of stoppage in
difference transit
Possession Right of lien is exercised Right of stoppage in transit
of goods when the goods are in is exercised hen the goods
possession of the seller. are in possession of the
carrier.
Insolvency It is not necessary that It is exercised only when
of buyer the buyer should be the buyer has been
declared as insolvent. declared as insolvent
Termination Seller looses the right of Seller looses the right of
of right lien as soon as the unpaid stoppage in transit as soon
seller losses the as the carrier losses the
possession of goods. possession of goods
Essence of To retain the possession To regain the possession of
right of goods back. goods from the carrier.

UNIT III
PARTNERSHIP ACT
Introduction
A partnership is the relationship between persons who have agreed to
share the profits of a business carried on by all or any of them acting
or all. In India it is governed by the Indian Partnership Act, 1932,
which extends to the whole of India except the State of Jammu and
Kashmir. It came into force on 1st October 1932.
Eligibility
A partnership agreement can be entered into between persons who are
competent to contract. Every person who is of the age of majority
according to the law to which he is subject and who is of sound mind
and is not disqualified from contracting by any law to which he is
subject can enter into a partnership.
The following can enter into a partnership
1. INDIVIDUAL
2. FIRM
3. HINDU UNDIVIDED FAMILY
4. COMPANY
5. TRUSTEES
1. INDIVIDUAL: An individual, who is competent to contract, can
become a partner in the partnership firm. If there are more than two
partners in a firm, an individual can be a partner in his individual
capacity as well as in a representative capacity as Karta of the Hindu
undivided family.
2. FIRM: A partnership firm is not a person and therefore a firm
can not enter into partnership with any firm or individual. But a
partner of the partnership firm can enter into partnership with other
persons and he can share the profits of the said firm with his other co-
partners of the parent firm.
3. HINDU UNDIVIDED FAMILY: A Karta of the Hindu
undivided family can become a partner in a partnership in his
individual capacity, provided the member has contributed his self
acquired or personal skill and labour.

4. COMPANY: A company is a juristic person and therefore can
become a partner in a partnership firm, if it is authorised to do so by
its objects.
5. TRUSTEES: Trustees of private religious trust, family trust and
trustees of Hindu mutts or other religious endowments are juristic
persons and can therefore enter into partnership, unless their
constitution or objects forbid.
6. NUMBER OF PARTNERS
The number of partners in a firm shall not exceed 20 and a partnership
having more than 20 persons is illegal. When there is partnership
between two firms, all the partners of each firm will be taken into
account. If the partnership is between the karta or member of Hindu
undivided family the members of the joint Hindu family will not be
taken into account.
Essentials of Partnership
1. AGREEMENT- The relationship between partners arises from
contract and not status. If after the death of sole proprietor of a firm,
his heirs inherit firm they do not become partners, as there is no
agreement between them.
2. SHARING OF PROFITS- The partners may agree to share
profits out of partnership business, but not share the losses. Sharing of
losses is not necessary to constitute the partnership. The partners may
agree to share the profits of the business in any way they like.
3. BUSINESS- Business includes every trade, occupation, or
profession. There must be course of dealings either actually continued
or contemplated to be continued with a profit motive and not for sport
or pleasure.
4. RELATION BETWEEN PARTNERS- The partner while
carrying on the business of the partnership acts a principle and an
agent. He is a principal because he acts for himself, and he is an agent
as he simultaneously acts for the rest of the partners.
General duties of a partner
1. Subject to a contract to the contrary between the partners the
following are the duties of a partner.
2. To carry on the business of the firm to the greatest common
advantage. Good faith requires that a partner shall not obtain a private

advantage at the expense of the firm. Where a partner carries on a
rival business in competition with the partnership, the other partners
are entitled to restrain him.
3. To be just and faithful. Partnership as a rule is presumed to be
based on mutual trust and confidence of each partner, not only in the
skill and knowledge, but also in the integrity, of each other partner
4. To render true accounts and full information of all things done
by them to their co-partners.
5. To indemnify for loss caused by fraud. Every partner shall
indemnify the firm for loss caused to it by his fraud in the conduct of
the business of the firm.
6. Not to carry on business competing with the firm. If a partner
carries on any business of the same nature as and competing with that
of the firm, he shall account for and pay to the firm all profits made
by him in that business.
7. To indemnify the firm for wilful neglect of a partner. A partner
shall indemnify the firm for any loss caused to it by his wilful neglect
in the conduct of the business of the firm.
8. To carry out the duties created by the contract. The partners are
bound to perform all the duties created by the agreement between the
partners.
Rights of the partnersSubject to a contract to the contrary a partner
has the following rights.
1. To take part in the conduct and management of the business
2. To express opinion in matters connected with the business. He
has a right to be consulted and heard in all matters affecting the
business of the firm
3. To have free access to all the records, books of account of the
firm and take copy from them.
4. To share in the profits of the business. Every partner is entitled
to share in the profits in proportion agreed to between the parties.
5. To get interest on the payment of advance. Where a partner
makes for he purpose of the business, any payment or advance
beyond the amount of capital he has agreed to subscribe, he is entitled
to interest thereon at the rate of 6% per annum.

6. To be indemnified by the firm against losses or expenses
incurred by him for the benefit of the firm.
Restrictions on authority of partner”-Restrictions are governed by
Contract and by the Partnership Act The partners may by contract
extend or restrict the implied authority of any partner.Under the
Partnership Act in the absence of any usage of trade to the
contrary, the implied authority of a partner does not empower
him to do the following acts:
1. Submit a dispute relating to the business of a firm to arbitration
2. Open a bank account in his own name
3. Compromise or relinquish any claim of the firm
4. Withdraw a suit or proceeding on behalf of the firm
5. Admit any liability in a suit or proceeding against the firm
6. Acquire immovable property on behalf of the firm
7. Transfer immovable property belonging to the firm, or
8. Enter into partnership on behalf of the firm.
Rights of a Minor
1. A person who is a minor according to the law to which he is
subject may not be a partner in a firm, but, with the consent of all the
partners for the time being, he may be admitted to the benefits of
partnership.
2. Such minor has a right to such share of the property and of the
profits of the firm as may be agreed upon, and he may have access to
and inspect and of the accounts of the firm.
3. Such minor's share is liable for the acts of the firm, but the
minor is not personally liable for any such act.
4. Such minor may not sue the partners for an account or payment
of his share of the property or profits of the firm
5. At any time within six months of his attaining majority, or of his
obtaining knowledge that he had been admitted to the benefits of
partnership, whichever date is later, such person may give public
notice that he has elected to become or that he has elected not to
become a partner in the firm, and such notice shall determine his
position as regards the firm, provided that, if he fails to give such
notice, he shall become a partner in the firm on the expiry of the said
six months.

6. Where any person has been admitted as a minor to the benefits
of partnership in a firm, the burden of proving the fact that such
person had no knowledge of such admission until a particular date
after the expiry of six months of his attaining majority shall lie on the
person asserting that fact.
 Where such person becomes a partner-
1. his rights and liabilities as a minor continue upto the date on
which he becomes a partner, but he also becomes personally liable to
third parties for all acts of the firm done since he was admitted to the
benefits of the partnership, and
2. his share in the property and profits of the firm shall be the share
to which he was entitled as a minor.
3. Where such person elects not to become a partner-
4. his rights and liabilities shall continue to be those of a minor
upto the date on which he gives public notice,
5. his share shall not be liable for any acts of the firm done after
the date of the notice, and
6. he shall be entitled to sue the partners for his share of the
property and profits.
7. Whenever there is an admission of a new partner or retirement of
a partner, or expulsion or insolvency of a partner, etc., the partnership
firm undergoes reconstitution. Sections 31 to 35 of the Indian
Partnership Act, 1932 help us understand the legal consequences of a
partner coming in or going out. Let us take a look.
Admission of a Partner (Section 31)
According to this section, the consent of all the existing partners is
necessary before introducing a new partner into a partnership firm. This
is subject to the provisions of Section 30 regarding minors in the firm.
Further, the new partner has no liability for any actions of the firm done
before his admission.
Rights and Liabilities of a New Partner
1.All liabilities of a new partner commence from the date of his
admission as a partner in the firm. This is unless he accepts liability for
the obligations incurred by the firm before his admission.
2. After the admission of a new partner, the new firm may agree to
assume liability for the debts of the old firm and the creditors may

accept the new firm as their debtor, discharging the old firm. It is
important to note that the creditor’s consent is important to make the
transaction operative.
3.In a contract, the technical term for substituted liability is Novation.
Hence, a mere agreement amongst the partners cannot operate as
Novation unless the creditors provide their consent.
Retirement of a Partner (Section 32)
A partner retires when he ceases to be a member of the firm without
ending the subsisting relations between the other members of the firm
or between the firm and other parties. If a partner withdraws from a
firm by dissolving it, then it is a dissolution and not retirement of a
partner. The retirement of a partner from a firm does not dissolve it.
In a partnership, a partner may retire:
 With the consent of all the partners,
 In accordance with an express agreement by the partners, or
 The partnership is at will, by giving notice in writing to all the
other partners of his intention to retire
Liabilities of an Outgoing Partner
A retired partner continues to be liable to the third party for acts of the
firm till such time that he or other members of the firm give a public
notice of his retirement. However, if the third party deals with the firm
without knowing that he was a partner in the firm, then he will not be
liable to the third party.
The retired partner, however, continues to be liable for acts of the firm
done before such retirement of a partner. This liability holds good
unless there is an agreement between him, the concerned third party,
and partners of the reconstituted firm. Such an agreement can also be
implied by the course of dealings between the third party and the
reconstituted firm post announcement of the retirement of a partner.
If the partnership is at will, then it can relieve a partner without giving a
public notice. To do so, the partnership needs to give a written notice to
all the partners of his intention to retire.
Expulsion of a Partner (Section 33)
A partnership firm can expel a partner provided:
 The power of expulsion exists in the contract between the
partners

 Majority of the partners exercise the power
 The power is used in good faith
If these conditions are not met, then the expulsion is not bona fide in the
interest of the business. The test of good faith includes three aspects:
1. The expulsion should be in the interest of the partnership.
2. Before expelling a partner the firm serves a notice to him.
3. The partner being expelled is given an opportunity to state his
version of events leading up to the expulsion.
If these aspects are not met, then the expulsion is not considered to be
made in good faith and is null and void. It is important to note that the
expulsion of partners does not necessarily result in the dissolution of the
firm.
Insolvency of a Partner (Section 34)
When a partner of a firm is adjudicated as insolvent –
 He ceases to be a partner of the firm from the date of the
adjudication
 Whether or not the firm subsequently dissolves
 His estate, which vests in the official assignee, ceases to be liable
for any act of the firm from the said date
 The firm ceases to be liable for any act of such a partner.
Liability of Estate of a Deceased Partner (Section 35)
Usually, the death of a partner results in the dissolution of the
partnership. However, if the partner’s contract to not dissolve the
partnership post the death of any partner, then the surviving partner
continue the business of the firm after absolving the deceased partner’s
estate from any liability of the future obligations of the firm.
Further, it is not necessary for the firm to give a public notice or inform
the persons dealing with the firm about the death of the partner.
An exception is a partnership consisting of only two partners. In such
cases, the death of a partner results in the dissolution of the partnership.
Dissolution of a firm A firm may be dissolved in the following
manner
 Dissolution by Court
 Dissolution by agreement
 Dissolution by operation of law
 Dissolution on the happening of certain contingencies

 Dissolution by notice
DISSOLUTION BY COURT:- The court may dissolve a firm at the
suit of any partners on any of the following grounds namely:
1. INSANITY OF A PARTNER: that a partner has become of
unsound mind. The insanity of a partner does not ipso facto dissolve
the firm and the next friend or continuing partners has to file suit foe
dissolution.
2. PERMANENT INCAPACITY OF A PARTNER: that a partner
has become permanently incapable of performing his duties as
partner.
3. CONDUCT AFFECTING PREJUDICIALLY THE BUSINESS:
that a partner is guilty of conduct, which is likely to affect
prejudicially the carrying on the business of the firm.
4. BREACH OF PARTNERSHIP AGREEMENT:that a partner
wilfully or persistently commits breach of agreements relating to the
management of the affairs of the firm or the conduct of it's business or
otherwise conducts himself in matters relating to the business, that it
is not reasonably practical for the other partners to carry on the
business with him.
5. TRANSFER OF INTEREST OF A PARTNER: that a partner
has in any way transferred the whole of his interest in the firm to a
third party.
6. LOSS: that the business of the firm cannot be carried on save at
a loss
7. JUST AND EQUITABLE: on any other ground that renders it
just an equitable that the firm should be dissolved.
DISSOLUTION BY AGREEMENT
A firm may be dissolved with the consent of all the partners or in
accordance with the contract between the partners. The partnership
agreement may contain a proviso that the firm will be dissolved on
the happening of certain contingency.
DISSOLUTION BY OPERATION OF LAW
1. A firm is compulsorily dissolved on the following grounds
2. Insolvency of partners
3. By the happening of any event which makes it unlawful for the
business of the firm to e carried on.

DISSOLUTION ON THE HAPPENING OF CERTAIN
CONTINGENCIES
Subject to contract between the partners a firm is dissolved on the
happening of the following contingencies.
 If constituted for a fixed term, by the expiry of that term
 If constituted to carry out one or more adventures or
undertakings, by its completion.
 By the death of a partner
 On insolvency of a partner
DISSOLUTION BY NOTICE
If the partnership is at will, the same may be dissolved by service of a
notice by one partner to dissolve the firm.
Registration
It is not compulsory to register the firm. However there are serious
effects of non-registration.
No suit to enforce a right arising from a contract or conferred by the
Indian Partnership Act shall be instituted in any court by or on behalf
of any person suing as partner in a firm against the firm or any person
suing as a partner in a firm against the firm or any person alleged to
be or to have been a partner in the firm, unless the firm is registered
and the person suing is or has been shown on the Register of firms as
a partner in the firm.
Similarly, no suit to enforce a right rising from a contract shall be
instituted in any court by or on behalf of a firm against any third party
unless the firm is registered.
PROCEDURE FOR REGISTRATION
The registration of a firm may be effected at any time by sending by
post or delivering to the Registrar of Firms of the area in which any
place of business of the firm is situated or proposed to be situated, a
statement in the prescribed form and accompanied by the prescribed
fee, stating:
the firm name;
 the place or principal place of business of the firm;
 the names of any other places where the firm carries on
business;
 the date when each partner joined the firm;

 the names in full and permanent addresses of the partners; and
 the duration of the firm.
behalf. Each person signing the statement shall also verify in the
manner prescribed.
A firm name shall not contain any of the following words viz.
"Crown", "Emperor", "Empress", "Empire", "Imperial", "King",
"Queen", "Royal", or words expressing or implying the sanction,
approval or patronage of Government, except when the State
Government signifies its consent to the use of such words as part of
the firm name by order in writing.
All the States have framed rules prescribing the forms, fee for
registration and verification of the statement. The application for
registration has to be made to the Registrar of Firms in the prescribed
form.
When the Registrar is satisfied that the provisions have been complied
with, he shall record and entry of the statement in a register called the
Register of Firms and shall file the statement. The Registrar is the
competent authority and if he acts bona fide and follows the
procedure, his satisfaction cannot be challenged.
CHECKLIST FOR DRAFTING A PARTNERSHIP DEED
A partnership deed should contain the following clauses
 Name of the parties
 Nature of business
 Duration of partnership
 Name of the firm
 Capital
 Share of partners in profits and losses
 Banking, Account firm
 Books of account
 Powers of partners
 Retirement and expulsion of partners
 Death of partner
 Dissolution of firm
 Settlement of disputes
 How to draft a Partnership Deed
NEGOTIABLE INSTRUMENT ACT

NEGOTIABLE INSTRUMENTS
The law of negotiable instruments i.e, Negotiable Instrument Act
1881 deals with promissory notes, bill of exchange and cheques. The
act applies to persons residents in
India , whether Indian or foreigner although its provisions are not
applicable to hundis and local instruments. Special customs govern
such instruments, however in case of their absence the Act will
equally apply to hundis also.
DEFINITION
“A negotiable instrument means a promissory note, bill of exchange
or cheque payable either to order or to bearer-Sec.13(1)
“A negotiable instrument is one the property in which is acquired by
energy person who takes it bonafide and for value, notwithstanding
any defect of title in the person from whom he takes it. The word
“negotiable” means “transferable by delivery” and the word
“instrument” means a “written document which creates a right in
favour of some other person”. Therefore it creates a right in favour of
some person which can be transferred by mere delivery.
PRE-CONDITIONS
An instrument will be a negotiable instrument if it satisfies the
following conditions:-
(a)It is in the form which is capable of being used of being used by
the holder for the time being in his own name.
(b)It is transferable by delivery.
Promissory Notes
Share warrants
Bills of exchange
Hundis
Cheques
Govt. Promissory notes
Banker’s Draft
Indira Vikas Patras

Port trust Debentures
Features of Negotiable Instruments:-

1. Good Title: The maxim”nemo dat quod non habet” i.e., “no one
can give a better title than he himself has” doesn’t apply on negotiable
instruments. So it means the transferee who takes in good faith and
for value will obtain a good title though the transferor may have had a
defective title or may not have title to it.
2. Property: A negotiable instruments does not merely give
possession of the instrument but the complete right to property also.
The property in case of bearer instrument, passes by mere delivery to
the transferee, but in case of order instrument, endorsement and
delivery will be required.
3. Negotiability: The property in negotiable instrument is freely
transferable from one person to another. In case of bearer instrument,
it is transferable by mere delivery and in case of order instrument; it is
transferable by endorsement and delivery.
4. Right to sue in own name: Where the negotiable instrument
is dishonoured, the transferee of that negotiable instrument has the
right to sue in his own name for the recovery of the amount.
5. Presumptions: Certain presumptions are applicable to all the
negotiable instruments e.g., The holder does not have to give notice to
any holder to establish his/her title.
6. Prompt Payment: Prompt payment is ensured in case of
negotiable instrument as in case of dishonour, the transferee can sue
in his name for the recovery of the amt. and thus the goodwill of both
the parties may be ruined.
Presumptions as to negotiable instruments
Presumptions are the rules which are assumed to be present in every
negotiable instrument unless it is proved otherwise. The following are
the presumptions as specified under Sec.118 & 119 of the Act itself:
 Consideration
All the negotiable instruments have presumed to be made, drawn,
accepted or endorsed for some lawful consideration. Unless it is
proved that the instrument was obtained by means of fraud or undue
influence or for unlawful consideration.
 Date
Every negotiable instrument is presumed to be made or drawn on the
date which is written on it until an unless it is proved otherwise.

 Time of acceptance
Every accepted bill of exchange is presumed to have been accepted
within a reasonable time after its issue and before its maturity unless
the contrary has been proved.
 Order of endorsement
It is presumed that the endorsements appearing upon a negotiable
instrument were made in the same order in which they appear.
 Stamp
It is always presumed that a lost or destroyed promissory note, bill of
exchange or cheque was duly stamped.
 Proof of protest
Until and unless it is disapproved, in a suit upon an instrument which
has been dishonoured, the court shall on proof of the protest, presume
the fact of dishonour.
 Holder in due course
Every holder of a negotiable instrument is presumed to have paid
consideration for it and to have taken it in good faith, until it is proved
otherwise.
A “promissory note” is an instrument in writing (not being a bank-
note or a currency-note) containing an unconditional undertaking,
signed by the maker, to pay a certain sum of money only to, or to the
order of, a certain person, or to the bearer of the instrument. [Section
4].
A written, dated and signed two-party instrument containing an
unconditional promise by the maker to pay a definite sum of money to
a payee on demand or at a specified future date
Examples of a promissory note:
(a) "I promise to pay Anil on order Rs.50000".
(b) "I acknowledge myself to be indebted to Tina in Rs.10, 000, to
be paid on demand, for value received."
(c) “I promise to pay Tanisque Rs.6000 First deducting thereout any
money which he may owe me.”
(d) “I acknowledge myself to be indebted to Ram Rs.3500 to be
paid on demand for value received.”
The instruments marked as (a) & (b) are the promissory notes while
(c) & (d) are not promissory notes.
PARTIES TO THE PROMISSORY NOTES:-
i. The Maker or Drawer – the person who makes the note and
promises to pay the amount
ii. The Payee – the person to whom the amount is payable.
Rs. 10,000/- Ambala
Aug 11, 2008
On demand, I promise to pay Ramesh, s/o RamLal of Panchkula or order a sum of Rs

10,000/- (Rupees Ten Thousand only), for value received.
Essentials of a promissory note:

 It must be in writing:-A promissory note must always be in
writing,
To duly signed by its maker and properly stamped as per Indian
Stamp Act. Mere verbal promise to pay somebody does not make any
Ramesh , Sd/
valid promissory note. Writing involves printing, photography, and
lithography.
Panchkulass……..
 Parties must be certain:-It is essential for the validity of a
promissory note that both parties to a promissory note, i.e. the maker
and the payee must be certain. Where these are not specified, it is not
a promissory note.
 Promise must be unconditional:-The maker of the promissory
note must make it unconditional, in order to make it valid. It is
unconditional when its performance does not depend upon the
fulilment of a particular condition or happening of an uncertain event
which may or may not occur.
 Sum to be paid must be certain:-The sum payable mentioned
must be certain or capable of being made certain. Where the
promissory note does not specify the amount of money.
 A promissory note cannot be made payable to the bearer.
 A Bank note or a currency note is not a promissory note as it
does not includes the promise made by maker to the payee.

 A promissory note may be payable on demand or after a definite
period of time.
BILLS OF EXCHANGE
A "bill of exchange" is an instrument in writing containing an
unconditional order, signed by the maker, directing a certain person to
pay a certain sum of money only to, or to the order of, a certain
person or to the bearer of the instrument.
FEATURES OF BILLS OF EXCHANGE:-
• A bill must be in writing, duly signed by its drawer, accepted
by its drawee and properly stamped as per Indian Stamp Act.
• ii. It must contain an order to pay. Words like ‘please pay Rs
5,000/- on demand and oblige’are not used.
• The order must be unconditional.
• The order must be to pay money and money alone.
• The sum payable mentioned must be certain or capable of being
made certain.
• The parties to a bill must be certain
Parties to Bills Of Exchange:-
i. DRAWER:-The maker of a bill of exchange or Cheque is
called the "drawer";
ii. DRAWEE:- The person thereby directed to pay is called the
"Drawee
iii. PAYEE:- The person named in the instrument, to whom or to
whose order the money is by the instrument directed to be paid, is
called the "payee
Specimen of Bills Of Exchange:-

Rs. 10,000/- New Delhi
May 2, 2001
Five months after date pay Tarun or (to his) order the sum of Rupees
Ten Thousand
only for value received.
To Accepted Stamp
Sameer
Difference between bills of Sameer S/d
exchange and promissory note
BILLS OF EXCHANGE
Address PROMISSORYRajiv
NOTE
There are three parties namely drawer, There are only two parties viz maker
drawee and payee and payee
The drawer and payee may be the same Maker cannot be the payee
person
There is an unconditional order to Contains an unconditional promise by
drawee to pay according to the the maker to pay to the payee or to his
drawer’s direction order
Payable after sight must be accepted by Presented for payment without any
the drawee or someone else on his prior acceptance by the maker
behalf before it can be presented for
payment
The liability of the drawer is secondary Liability of a maker of promissory
and conditional note is primary and absolute
CHEQUE
A "cheque" is a bill of exchange drawn on a specified banker and not
expressed to be payable or otherwise than on demand. Sec.6
A cheque being a biil of exchange must possess all the essentials of a
bill of exchange and should also meet the following additional
requirements of Section6:
1. A cheque must be drawn upon a specified banker.
2. A cheque must be payable on demand.
Features of a cheque
i. A cheque must be in writing and duly signed by the drawer.
ii. It contains an unconditional order.
iii. It is issued on a specified banker only.
iv. The amount specified is always certain and must be clearly
mentioned both in figures and words.
v. The payee is always certain.
vi. It is always payable on demand.
vii. The cheque must bear a date otherwise it is invalid and shall not
be honoured by the bank.
viii. A cheque must be addressed by one person to another. So draft is
not a cheque
ix The cheques are usually written on printed forms supplied by the
banks on their depositors.
SPECIMEN OF A CHEQUE
No. Dated………20
State Bank Of India
Pay………………………………………………Or Bearer
Rupees……………………………………………………..
…………………………………………………………..…
PARTIES TO CHEQUES:-
Rs…………………..
 Drawer
Account
Drawee
No……..
 Payee
Types of Cheques:-
i. Crossed cheque:-Since open cheque is subject to risk of
theft, it is dangerous to issue such cheques. This risk can be avoided
by issuing another types of cheque called ‘Crossed cheque’. The
payment of such cheque is not made over the counter at the bank. It is
only credited to the bank account of the payee. A cheque can be
crossed by drawing two transverse parallel lines across the cheque,
with or without the writing ‘Account payee’ or‘Not Negotiable’
ii. Bearer cheque:-A cheque which is payable to any person
who presents it for payment at the bank counter is called ‘Bearer
cheque’. A bearer cheque can be transferred by mere delivery and
requires no endorsement

iii. Order cheque:-An order cheque is one which is payable to a
particular person. In such acheque the word ‘bearer’ may be cut out or
cancelled and the word ‘order’ may be written. The payee can transfer
an order cheque to someone else by Crossing of Cheque – The Act
makes specific provisions for crossing of cheques.
i. CHEQUE CROSSED GENERALLY - Where a cheque
bears across its face an addition of the words “and company” or any
abbreviation thereof, between two parallel transverse lines, or of two
parallel transverse lines simply, either with or without the words “not
negotiable”, that addition shall be deemed a crossing, and the cheque
shall be deemed to be crossed generally. [section 123]
ii. CHEQUE CROSSED SPECIALLY - Where a cheque
bears across its face an addition of the name of a banker, either with
or without the words “not negotiable”, that addition shall be deemed a
crossing, and the cheque shall be deemed to be crossed specially, and
to be crossed to that banker. [section 124].
PAYMENT OF CHEQUE CROSSED GENERALLY OR
SPECIALLY - Where a cheque is crossed generally, the banker on
whom it is drawn shall not pay it otherwise than to a banker. Where a
cheque is crossed specially, the banker on whom it is drawn shall not
pay it otherwise than to the banker to whom it is crossed, or his agent
for collection. [section 126].
iii. CHEQUE BEARING “NOT NEGOTIABLE” - A person
taking a cheque crossed generally or specially, bearing in either case
the words “not negotiable”, shall not have, and shall not be capable of
giving, a better title to the cheque than that which the person form
whom he took it had. [section 130]. Thus, mere writing words ‘Not
negotiable’ does not mean that the cheque is not transferable. It is still
transferable, but the transferee cannot get title better than what
transferor had
Who can cross the cheque
1.The drawer: While issuing a cheque, the drawer can cross the
cheque
2.The holder:
(a)If the cheque is not crossed, he can cross the cheque generally or
specially.

(b)If the cheque is crossed generally then he can cross it specially.
(c)If the cheque is crossed generally or specially then he may add the
words “not negotiable”.
3. The banker:
(a)If the cheque is not crossed, & is sent to the bank for collection
then it can cross the cheque generally or specially.
(b)If the cheque is crossed generally is sent to the bank for collection
then it can cross it specially.
(c)If the cheque is crossed specially the banker to whom it is
crossed, may again cross it specifically to another banker for
collection.
Difference between Cheque And Bills of Exchange
Basis of difference
Cheque Bills of exchange
1.Drawee A cheque is always drawn It can be drawn on any
on a bank or a banker. person including a
banker.
2.Acceptance A cheque doesn’t require It requires the
any acceptance. acceptance of drawee.
3.Payment A cheque is paid It is normally entitled to
immediately on demand three days of grace.
without any grace period.
4.Crossing A cheque may be crossed A bill can’t be crossed.
5.Notice of Here notice of dishonour is Here the notice of
dishonour not required. Want of assets dishonour is essential
in the hands of banker is the
sufficient notice
6.Stamp It is not required here. Stamp is required to
make it valid.
7.Noting or It is not noted or protested. It is noted and protested
protesting in order to obtain the
proof of dishonour.
8.Countermanding A cheque may be revoked. A bill can’t be revoked.
payment
Liabilities of parties to a negotiable instrument
1.Liability of a drawer
(a)The drawer of a bill of exchange or cheque is bound in case of
dishonour by the drawee or acceptor thereof, to compensate the
holder( provided due notice of dishonour has been given to or
received by him).
(b) The liability of the drawer is conditional and only arises in the
event of dishonour.
2.Liability of a drawee or banker
(a)It is the liability of the banker to pay for a duly presented cheque
(provided there are sufficient funds in the account of the drawer).
(b)In the event of wrongful dishonor of a cheque wrongfully, the
banker is liable to the drawer and not the holder.
DISHONOURING OF CHEQUE
A bill of exchange can be dishonoured by non acceptance or buy non
payment, but a cheque and a promissory note can be dishonoured by
non payment only.
Following are the methods in which a negotiable instrument can be
dishonoured:-
Dishonour by non- acceptance.-(Section 97) A bill of exchange is
said to be dishonoured :-
1) By non-acceptance when the drawee, or one of several drawee
not being partners, makes default in acceptance upon being duly
required to accept the bill.
2) Where presentment is excused and the bill is not accepted.
3) Where the drawee is a fictitious person
4) Where the drawee has given a qualified acceptance.
5) Where the drawee is not competent to enter into a contract.
6) Where the drawee is not traceable after a reasonable search.
7) Where the drawee has been declared insolvent or has died.
8) Where the presentation of bill is excused.
Dishonour by non-payment.-( Section 92) A promissory note, bill of
exchange or cheque is said to be dishonoured :-
1) When the maker of the note, acceptor of the bill or drawee of the
cheque makes default in payment upon being duly required to pay the
same
2) Where it is not necessary to present the instrument for payment
but the instrument remains unpaid on maturity.
By and to whom notice should be given.-
When a promissory note, bill of exchange or cheque is dishonoured
by non-payment, the holder thereof, or some party thereto who
remains liable thereon, must given notice that the instrument has been

so dishonored to all other parties whom the holder seeks to make
severally liable thereon, and to some one of several partied whom he
seeks to make jointly liable thereon.
Nothing in this section renders it necessary to give notice to the maker
of the dishonored promissory note, or acceptor of the dishonored bill
of exchange or cheque.
Mode in which notice may be given.-
Notice of dishonor may be given to a duly authorized agent of the
person to whom it is required to be given, or , where he has died, to
his legal representative, or, where he has been declared an insolvent,
to his assignee, maybe oral or written, may, if written, be sent by post,
and may be in any form, but it must inform the party to whom it is
given, either in express terms or by reasonable intendment that the
instrument has been dishonoured, and in what way, and that he will be
held liable thereon, and it must be given within a reasonable time after
dishonor, at the place of business or ( in case such party has no place
of business) at the residence of the party for whom it is intended.
IF the notice is duly directed and sent by post and miscarries, such
miscarriage does not render the notice invalid.
Party receiving must transmit notice of dishonour.-
Any party receiving notice of dishonour must in order to render any
prior party liable to himself, give notice of dishonour to such party
within a reasonable time , unless such party otherwise receives due
notice as provided by section 93
When notice of dishonour is unnecessary.-
Notice of dishonour is necessary -
(a) when it is dispensed with by the party entitled thereto
(b) in order to charge the drawer, when he has countermanded
payment
(c) when the party charged could not suffer damage for want of notice
(d) when the party entitled to notice cannot after due search be found,
or the party bound to give notice is, for any other reason, unable
without any fault of his own to give it.
(e) to charge the drawers, when the acceptors is also a drawer.
(f) in the case of a promissory note which is not negotiable.

(g) when the party entitled to notice, knowing the facts, promise
unconditionally to pay the amount due on the instrument.

UNIT-IV
COMPANY LAW
introduction of COMPANIES ACT 1956
In simple words, a company can be defined as a group of persons
associated together for the purpose of carrying on a business, with a
view to earn profits. The word ‘Company’ is an amalgamation of the
Latin word ‘Com’ meaning “with or together” and ‘Pains’ meaning
“bread”. Thus, a company is nothing but a group of persons who have
come together or who have contributed money for some common
purpose and who have incorporated themselves into a distinct legal
entity in the form of a company for that purpose
DEFINITION
 Section 3(1)(i) of the Act provides that, “a company means a
company formed and registered under this Act or an existing
company.”
 Section 3(1)(ii) lays down that, “ An existing company means
a company formed and registered under any of the previous
companies laws .”
 Lindey, “A company is an association of many persons who
contribute money or money’s worth to a common stock and employ it
in some trade or business and who share the profit and loss arising
there from. The common stock so contributed is denoted in money
and is the capital of the company. The persons who contribute it or to
whom it belongs are members. The proportion of capital to which
each member is entitled is his share. The shares are always
transferable although the right to transfer is more or less restricted
FEATURES OF COMPANY :-
1. Separate Legal Entity:-A company has separate legal
entity means that it is different from the person who owes it. Its entity
is distinct from them. A company is intangible and exists only in the
eyes of law. It is an artificial person which is created by law and
destroyed by law. The assets and liabilities of a company are separate
than those of its owners or directors. The property of the company is
not the property of the shareholders.
2. Limited Liability:-Another feature of a company is that the
liability of the members of a company is limited i.e. at the time of
wound up of the company members are not forced to pay from their
personal assets. It can be either limited by share or limited by
guarantee.
(a)Limited by share:-It means that if the face value of the share is
Rs.100. Mr Ram has subscribed for 100 shares. On application he has
paid Rs.20, On allotment Rs.30 and after that the company wound up.
So at the time of winding up Mr.Ram has to pay only an uncalled
amount i.e Rs. 50 per share only.
(b)Limited by guarantee:-It means that liability of the member is
limited to the extent which he has taken to contribute to the assets of
the company at the time of winding u and nothing more than that.
Example if Mr. A has undertaken the guarantee that he will
contribute Rs.10000/- at the time of winding up of the company. Then
at the time of winding up company cannot ask anything more than
Rs.10000- from Mr.A.
3. Perpetual Succession:- In case of a partnership when a
partner dies, then partnership got dissolved. But in case of a company
even if one member or all the members dies still company is going on.
It is based on separate legal entity concept there is no concern
between the life of the company and life of the shareholder A
company is a immortal person. The life of the company will be put to
an end only by the process of law.
4. eparate Property:-This is another feature of the company.
A company can owe, purchase and sell property in its own name. The
property of the company belongs to itself and not to the member
shareholders. A member does not have even insurable interest in the
property of the company.
5. Transferability of Shares: It means that shares of the company
are easily transferable from one person to another. The shares of the
company are easily bought and sold in the stock market. There are
certain restrictions on the transferability of shares in case of a private
company.
6. Capacity to sue and Being Sued:- On getting the certificate of
incorporation a company acquired a status of a separate legal entity.
Just like a natural person it can sue and can be sued in its own name.

7. Common seal:-Since company is a artificial person it cannot
sign its name on a contract. So it functions with the help of a seal.
Seal is a substitute for the signature. Every company has a seal with
its name engraved on it. Every document of the company should have
a seal on it else it will not be treated as a authentic document and
company will not be bind by it.
8. Separate management:- This is another feature of a
company that it has separate management which means that it is not
essential that the owners are managing the affairs of the company.
Company is owned by different individuals called shareholders while
company is managed by the board of directors.
Distinction between Company and Partnership:-
1. Separate legal entity:-.Partnership firm does not have a
separate legal entity. The company has a separate legal entity as soon
as it is incorporated under law.
2. Liability:-Liability of the partners is unlimited. However, the
liability of shareholders of a limited company is limited to the extent
of unpaid share or to the tune of the unpaid amount guaranteed by the
shareholder
3. Auditing of accounts:- It is not essential to get the accounts
audited at the end of financial year by Chartered accountant , whereas
it is essential in case of a company.
4. Liability:-In case of partnership liability is unlimited and in
case of company it is limited by share or by guarantee.
5. Property:- Property of the firm belongs to the partners and they
are collectively entitled to it. In case of a company, the property
belongs to the company and not to its members.
6. Transferability of shares:-A partner cannot transfer his shares
in the partnership firm without the consent of all other partners. In
case of a company, shares may be transferred without the permission
of the other members, in absence of provision to contrary in articles of
association of the company
7. Maximum number of members:-In case of partnership, the
number of members must not exceed 20, in case of banking business
it is 10.. A Public company may have as many members as it desires

subject to a minimum of 7 members. A Private company cannot have
more than 50 members.
8. Minimum number of members:- There must be at least 2
members in order to form a partnership firm. The minimum number
of members necessary for a public limited company is seven and two
for a private limited company
9. Consensus:-In case of a partnership, 100 % consensus is
required for any decision. In case of a company, decision of the
majority prevails.
10. Perpetual of succession:-In the case of the death of any partner,
the partnership is dissolved.. On the death of the shareholder, the
company’ existence does not get terminated.
11. Act: -Partnership is under partnership act1932. Company act is
covered under companies act1956
Private company:-
It means a company :-
1. which has a minimum paid-up capital of one lakh rupees or such
higher paid-up capital as may be prescribed, and by its articles,
2. restricts the right to transfer its shares,
3. limits the number of its members to fifty
4. It can’t invite general public to subscribes for shares or
debentures
Provided that where two or more persons hold one or more shares in a
company jointly, they shall, for the purposes of this definition, be
treated as a single member
Public company:-
It means a company :-
1. which has a minimum paid-up capital of five lakh rupees or
such higher paid-up capital as may be prescribed, and by its articles,
2. the right to transfer its shares,
3. No limit of members
4. It can invite general public to subscribes for shares or
debentures
Difference between Public Company and Private Company :-
1. Minimum Paid-up Capital : A company to be Incorporated as a
Private Company must have a minimum paid-up capital of Rs.

1,00,000, whereas a Public Company must have a minimum paid-up
capital of Rs. 5,00,000.
2. Minimum number of members : Minimum number of members
required to form a private company is 2, whereas a Public Company
requires atleast 7 members.
3. Maximum number of members : Maximum number of members
in a Private Company is restricted to 50, there is no restriction of
maximum number of members in a Public Company
4. Transferability of shares : There is complete restriction on the
transferability of the shares of a Private Company through its Articles
of Association , whereas there is no restriction on the transferability
of the shares of a Public company
5. Issue of Prospectus : A Private Company is prohibited from
inviting the public for subscription of its shares, i.e. a Private
Company cannot issue Prospectus, whereas a Public Company is free
to invite public for subscription i.e., a Public Company can issue a
Prospectus
6. Number of Directors : A Private Company may have 2 directors
to manage the affairs of the company, whereas a Public Company
must have atleast 3 directors.
7. Consent of the directors : There is no need to give the consent by
the directors of a Private Company, whereas the Directors of a Public
Company must have file with the Registrar a consent to act as
Director of the company.
8. Qualification shares : The Directors of a Private Company need
not sign an undertaking to acquire the qualification shares, whereas
the Directors of a Public Company are required to sign an undertaking
to acquire the qualification shares of the public Company
9. Commencement of Business : A Private Company can commence
its business immediately after its incorporation, whereas a Public
Company cannot start its business until a Certificate to
commencement of business is issued to it.
10. Shares Warrants : A Private Company cannot issue Share
Warrants against its fully paid shares, Whereas a Public Company can
issue Share Warrants against its fully paid up shares.

11. Further issue of shares : A Private Company need not offer the
further issue of shares to its existing share – holders, whereas a Public
Company has to offer the further issue of shares to its existing share –
holders as right shares. Further issue of shares can only be offer to the
general public with the approval of the existing share – holders in the
general meeting of the share – holders only
12. Quorum : The quorum in the case of a Private Company is two
members present personally, whereas in the case of a Public Company
five members must be present personally to constitute quorum.
However, the Articles of Association may provide and number of
members more than the required under the Act.
13 Managerial remuneration : Total managerial remuneration in the
case of a Public Company cannot exceed 11% of the net profits, and
in case of inadequate profits a maximum of Rs. 87,500 can be paid.
Whereas these restrictions do not apply on a Private Company.
14.. Special privileges : A Private Company enjoys some special
privileges, which are not available to a Public Company
FORMATION OF A COMPANY
A company passes through 3 stages:-
1. Promotional stage
2. Incorporation stage
3. Commencement of business
1. Promotional stage
Few important decisions are to be taken before starting a company.
Some of them are important and some are less important
Important matters:-
 Whether to start a new company alltogether or
 To acquire already running business.
Other matters:-
 Size of the company
 Capital involved in the project
 Sources of capital
2. Incorporation stage
It is to ascertain from the registrar whether the proposed name shall
be approved if registration is sought for such name or not. If the
registrar approve the name then he will issue them a certificate o

incorporation under his hand. Public company . has to write a word
“ltd..” at the end of the name and Private company has to write “pvt.
ltd.”at the end.
A private co. can start its business after getting the certificate of
incorporation
Effects of registration and incorporation:-
 The co. will become a separate legal entity on the date of getting
this certificate.
 It acquires perpetual succession
 The co. can sue and be sued in its own name
 It can acquire property in its own name
Conclusiveness of certificate of incorporation::-
The certificate issued by the registrar is the conclusive evidence that
all the requirements of the company’s act have been complied with.
Certificate Of Incorporation is the proof that all the formalities are
fulfilled and nothing can be inquired into the proceedings. A
certificate of incorporation given by the Registrar in respect of any
association shall be conclusive evidence that all the requirements of
this Act have been complied with in respect of registration and
matters precedent and incidental thereto, and that the association is a
company authorized to be registered and duly registered under this
Act
Moosa Gulam Arif v.Ibrahim Gulam Arif-
The Memorandum Of Association was signed by two adults and a
guardian of other five members, who were minors. The registrar,
however, registered the company and issued under his hand a
certificate of incorporation. The court held the certificate to be
conclusive for all purposes.
2. Commencement of business:-
A public co. has to obtain this certificate before starting its business.
This certificate will be issued by the registrar under following
circumstances:-
1. Company having share capital and had issued prospectus:-
Where a public co. having share capital and had issued prospectus
inviting a general public to apply for shares and debentures, it cannot
be issued a certificate of COB & it cannot starts a business until:-

 Shares have been allotted to the extent of minimum subscription
 Director have paid the application and the allotment money for
the shares taken by them
 Shares have been dealt with registered stock exchange.
 A statutory declaration duly verified by one of the Director of
the secretary of the co. that the above conditions have been complied
with and have been filed with the registrar
2. Company having share capital and not issued prospectus:-
Certificate Of Commencement Of Business cannot be issued until:-
 A statement in lieu of prospectus have been filed with the
registrar.
 Director have paid the application and the allotment money for
the shares taken by them
 A statutory declaration duly verified by one of the Director of
the secretary of the co. that the above conditions have been complied
with and have been filed with the registrar
Where the company has fulfilled the above noted requirements , the
registrar will issue a certificate of Commencement Of Business and
the company becomes eligible to commence its business.
If the company contravenes with thr above said provision then every
person responsible for it will be fined Rs.5000 per day till the default
continues
Memorandum of association
Memorandum of association is one of the documents which has to
filed with the registrar of companies at the time of incorporation of a
company. Section 2(28)defines a memorandum to mean “the
memorandum of association of a company as originally framed or as
altered from time to time in pursuance of any previous company law
or of this act.” The definition, however, either does not give us any
idea as to what a memorandum of association really is nor does it
point out the role which it plays in the affairs of the company.
The memorandum of association is an extremely important document
in relation to the affairs of the company. It is a document which sets
out the constitution of the company and is really the foundation on
which the structure of the company is based. It contains the
fundamental conditions upon which alone the company is allowed to

be incorporated. A company may pursue only such objects and
exercise only such powers as are conferred expressly in the
memorandum or by implication therefore i.e. such powers as are
incidental to the attainment of the objects. A company cannot depart
from the provisions contained in its memorandum, however, great the
necessity may be. If it does, it defines its relation with the outside
world and the scope of its activities. The purpose of the memorandum
is to enable shareholders, creditors and those who deal with the
company to know what is the permitted range of the enterprise.
It defines as well as confines the powers of the company; it not only
shows the object of its formation, but also the utmost possible scope
of its operation beyond which its action cannot go. Lord Cairns in
Ashbury Railway Carriage Co. V. Riche pointed out,” The
memorandum is as it were, the area beyond which the action of the
company cannot go; inside that area the shareholders may make such
regulations for their own government as they think fit.”
Purpose of memorandum:
The purpose of the memorandum is two fold.
1. The intending share holder who contemplates the investment of his
capital shall know within what field it is to be put at risk.
2. Anyone who shall deal with the company shall know without
reasonable doubt whether the contractual relation into which he
contemplates entering with the company is one relating to a matter
within its corporate objects.
At least seven persons in the case of public company and at least two
in the case of a private company must subscribe to the memorandum.
The memorandum shall be printed, divided into consecutively
numbered paragraphs, and shall be signed by each subscriber, with his
address, description and occupation added, the presence of at least
one witness who will attest the same.
Contents of Memorandum:
According to section 13, the memorandum of association of every
company must contain the following clauses:
1. The name of the company with ‘limited’ as the last word of the
name in the case of a public limited company and with ‘private
limited’ as the last word in the case of a private limited company.

2. The state in which the registered office of the company is to be
situated.
3. The objects of the company to be classified as:
a. The main objects of the company to be pursued by the company on
its incorporation and objects incidental to the attainments of the main
objects, and
b. Other objects not included above
4. In the case of companies with object not confined to one state, the
states to whose territories the objects extend.
5. The liability of members is limited if the company is limited by
shares or by guarantee.
6. In the case of a company having a share capital, the amount of
share capital with which the company proposes to be registered and
its division into shares of a fixed amount.
An unlimited company need not include items 5 and 6 in its
memorandum.
In the case of a company limited by guarantee, its memorandum of
association shall state that each member undertakes to contribute to
the assets of the company, in the event of its being wound up while he
is a member or within or year after wards for the payment of the debts
and liabilities of the company.
Every subscriber to the memorandum shall take at least one share and
shall write opposite to his name the number of shares taken by him.
Different clauses:
A brief discussion of the various clauses are as follows:
Name clause:
A company may be registered with any name it likes. But no company
shall be registered by a name which in the opinion of the central
government is undesirable and in particular which is identical or
which too nearly resembles the name of an existing company. Where
a company is registered by a name so similar to that of another
company, that the public are likely to be deceived, the court will grant
an injunction restraining it from using that name.
Every public company must write the word ‘limited’ after its name
and every private limited company must write the word ‘private
limited’ after its name. The use of the word ‘company’ is however,

not compulsory. Companies, whose liabilities are not limited, are
prohibited from using the word ‘limited’. The words ‘limited’ may be
dispensed with in the name of charitable companies. But companies
formed to promote art, science, religion etc, which do not propose to
pay dividend but intend to apply all its profits towards the working of
the company, can be registered without the word ‘limited’ under
licenses granted by the central government.
A company cannot adopt a name which violates the provisions of the
emblems and names act 1950. This act prohibits the use of the name
and emblems of the united nation, and the world health organization,
the official seal and emblem of the central and the state governments,
the Indian National Flag, the name and pictorial representation of
Mahatma Gandhi and the prime minister of India.
If a limited company makes a contract without using the word
‘limited’ the directors who make the contract on behalf of the
company would be personally liable.
Every company is required to publish its name outside its registered
office, and outside every place where it carries on business, to have its
name engraved on its seal and to have its name on all business letters,
bill heads, notices and other official publications of the company.
Registered office clause:
This clause states the name of the state where the registered office of
the company is to situate. The registered office clause is important for
two reasons. Firstly, it ascertains the domicile and nationality of a
company. This domicile clings to it throughout its existence.
Secondly, it is the place where various registers relating to the
company must be kept and to which all communications and notices
must be sent. A company need not carry on its business at its
registered office.
A company shall have its registered office. Such office must be in
existence from the date on which the company begins to carry on
business or within 30 days after incorporation, whichever is earlier.
Notice of situation of the registered office and every change therein
must be given within 30 days from the date of incorporation of the
company of after the date of change, as the case may be.

Objects clause:
The objects clause is the most important clause in the memorandum
of association of a company. It is not merely a record of what is
contemplated by the subscribers, but it serves a two-told purpose:
(a) It gives an idea to the prospective shareholders the purposes for
which their money will be utilized.
(b) It enables the persons dealing with the company to ascertain its
powers.
In case of companies which were in existence immediately before the
commencement of the companies’ act 1965, the objects clause has
simply to state the objects of the company. But in the case of a
company to be registered after the amendment, the objects clause
must state separately:
(a) Main objects. This sub-clause has to state the main objects to be
pursued by the company on its incorporation and objects incidental or
ancillary to the attainment of the main objects.
(b) Other objects. This sub-clause shall state other objects which are
not included in the above clause.
Further, in the case of a non-trading company. Whose objects are not
confined to one states clause must mention specifically the states to
whose territories the objects extend.
The subscribers to the memorandum of association may choose and
object or objects for their company. There are, however, certain
restrictions.
1. The objects should not be against the policy of the constitution. For
example, the object should not be such as to encourage untouched
ability which has been abolished under our constitution.
2. The objects should not include anything which is illegal or against
public policy. For example, forming a company for dealing in
lotteries or for trading with the alien enemies.
3. The object must not be against the provisions of the companies act,
as for example, authorizing the company to purchase its own shares.
On its being registered, the company has power to do whatever is
necessary to do for attaining the objects stated in the memorandum,
and to do whatever else is incidental to or consequential upon the
attainment of the main object. It is, therefore, clear that any act of the

company outside its stated, objects is ultra viruses and therefore void
and cannot be ratified even by the whole body of shareholders.
Liability clause:
This clause states that the liability of the members of the company is
limited. In the company is limited. In the case of a company limited
by shares, the member is liable only to the amount unpaid on the
shares taken by him. In the case of a company limited by guarantee
the members are liable to the amount undertaken to be contributed by
them to the assets of the company in the event of its being wound up.
However, this clause is omitted from the memorandum of association
of unlimited companies.
Any alteration in the memorandum compelling a member to take up
more shares, or which increases his liability, would be null and void.
If a company carries on business for more than six months, while the
number of members is less than 7, in the case of public company and
less than 2 in case of a private company each member aware of this
fact, is liable for all the debts contracted by the company after the
period of six months has elapsed.
Capital clause:
The memorandum of a company limited by shares must state the
authorized or nominal share capital, the different kinds of shares, the
authorized or nominal share capital, the different kinds of shares, and
the nominal value of each share. The capital clause need not state
anything else and it is usually better that it should not do so.
Association or subscription clause:
This clause provides that those who have agreed to subscribe to the
memorandum must signify their willingness to associate and form a
company. According to section 12 of the act, at least seven persons
are required to sign the memorandum in the case of a public company,
and at least two persons in the case of a private company.
The memorandum has to be signed by each subscriber in the presence
of at least one witness who must attest the signatures. Each subscriber
must write opposite his name the number of shares he shall take. No
subscriber of the memorandum shall take less than one share. This
clause need not be numbered.

The object clause of the Memorandum of the company contains the
object for which the company is formed. An act of the company must
not be beyond the objects clause, otherwise it will be ultravires and,
therefore, void and cannot be ratified even if all the members wish to
ratify it. This is called the doctrine of ultra vires, which has been
firmly established in the case of Ashtray RailwayCarriage and Iron
Company Ltd v. Riche. Thus the expression ultra vires means an act
beyond the powers. Here the expression ultra vires is used to indicate
an act of the company which is beyond the powers conferred on the
company by the objects clause of its memorandum. An ultra vires act
is void andcannot be ratified even if all the directors wish to ratify it.
Sometimes the expression ultra vires is used to describe the situation
when the directors of a company have exceeded the powers delegated
to them. Where a company exceeds its power as conferred on it by the
objects clause of its memorandum, it is not bound by it because it
lacks legal capacity to incur responsibility for the action, but when the
directors of a company have exceeded the powers delegated to them.
This use must be avoided for it is apt to cause confusion between two
entirely distinct legal principles. Consequently, here we restrict the
meaning of ultra vires objects clause of the company’s memorandum.
Basic principles included the following:
1. An ultra vires transaction cannot be ratified by all the
shareholders, even if they wish it to be ratified.
2. The doctrine of estoppel usually precluded reliance on the
defense of ultra vires where the transaction was fully performed by
one party
3. A fortiori, a transaction which was fully performed by both
parties could not be attacked.
4. If the contract was fully executory, the defense of ultra vires
might be raised by either party.
5. If the contract was partially performed, and the performance was
held to be insufficient to bring the doctrine of estoppel into play, a
suit for quasi contract for recovery of benefits conferred was
available.

6. If an agent of the corporation committed a tort within the scope
of his or her employment, the corporation could not defend on the
ground the act was ultra vires.
EFFECT OF ULTRA VIRES TRANSACTIONS
A contract beyond the objects clause of the company’s memorandum
is an ultra vires contract and cannot be enforced by or against the
company as was decided in the cases of In Re, Jon Beaufore (London)
Ltd ., (1953) Ch. 131, In S. Sivashanmugham And Others v. Butterfly
Marketing PrivateLtd., (2001) 105 Comp. Cas Mad 763,
A borrowing beyond the power of the company (i.e. beyond the
objects clause of the memorandum of the company) is called ultra
vires borrowing.
However, the courts have developed certain principles in the interest
of justice to protect such lenders. Thus, even in a case of ultra vires
borrowing, the lender may be allowed by the courts the following
reliefs:
(1) Injunction — if the money lent to the company has not been spent
the lender can get the injunction to prevent the company from parting
with it.
(2) Tracing— the lender can recover his money so long as it is found
in the hands of the company in its original form.
(3) Subrogation—if the borrowed money is applied in paying off
lawful debts of the company, the lender can claim a right of
subrogation and consequently, he will stand in the shoes of thecreditor
who has paid off with his money and can sue the company to the
extent the money advanced by him has been so applied but this
subrogation does not give the lender the same priority that the original
creditor may have or had over the other creditors of the company.
EXCEPTIONS TO THE DOCTRINE OF ULTRA VIRES
There are, however, certain exceptions to this doctrine, which are as
follows:
1. An act, which is intra vires the company but outside the authority
of the directors may be ratified by the shareholders in proper form.20
2. An act which is intra vires the company but done in an irregular
manner, may be validated by the consent of the shareholders. The

law, however, does not require that the consent of all the shareholders
should be obtained at the same place and in the same meeting.
3. If the company has acquired any property through an investment,
which is ultra vires, the company’s right over such a property shall
still be secured.
4. While applying doctrine of ultra vires, the effects which are
incidental or consequential to the act shall not be invalid unless they
are expressly prohibited by the Company’s Act.
5. There are certain acts under the company law, which though not
expressly stated in the memorandum, are deemed impliedly within the
authority of the company and therefore they are not deemed ultra
vires. For example, a business company can raise its capital by
borrowing.
6. If an act of the company is ultra vires the articles of association, the
company can alter its articles in order to validate the act.
CASE NOTES:
Eley v The Positive Government Security Life Assurance
Company, Limited, (1875-76) L.R. 1 Ex. D. 88
It was held that the articles of association were a matter between the
shareholders inter se, or the shareholders and the directors, and did
not create any contract between the plaintiff and the company and
article is either a stipulation which would bind the members, or else a
mandate to the directors. In either case it is a matter between the
directors and shareholders, and not between them and the plaintiff.
The Directors, &C., of the Ashbury Railway Carriage and Iron
Company (Limited) v Hector Riche, (1874-75) L.R. 7 H.L. 653.
The objects of this company, as stated in the Memorandum of
Association, were to supply and sell the materials required to
construct railways, but not to undertake their construction. The
contract here was to construct a railway. That was contrary to the
memorandum of association; what was done by the directors in
entering into that contract was therefore in direct contravention of the
provisions of the Company Act, 1862
It was held that this contract, being of a nature not included in the
Memorandum of Association, was ultra vires not only of the directors
but of the whole company, so that even the subsequent assent of the

whole body of shareholders would have no power to ratify it. The
shareholders might have passed a resolution sanctioning the release,
or altering the terms in the articles of association upon which releases
might be granted. If they had sanctioned what had been done without
the formality of a resolution, that would have been perfectly
sufficient. Thus, the contract entered into by the company was not a
voidable contract merely, but being in violation of the prohibition
contained in the Companies Act , was absolutely void. It is exactly in
the same condition as if no contract at all had been made, and
therefore a ratification of it is not possible. If there had been an actual
ratification, it could not have given life to a contract which had no
existence in itself; but at the utmost it would have amounted to a
sanction by the shareholders to the act of the directors, which, if given
before the contract was entered into, would not have made it valid, as
it does not relate to an object within the scope of the memorandum of
association.
Shuttleworth v Cox Brothers and Company (Maidenhead),
Limited, and Others, [1927] 2 K.B. 9
It was held that
 the contract, if any, between the plaintiff and the company
contained in the articles in their original form was subject to the
statutory power of alteration and
 if the alteration was bona fide for the benefit of the company it
was valid and there was no breach of that contract;
 there was no ground for saying that the alteration could not
reasonably be considered for the benefit of the company;
 there being no evidence of bad faith, there was no ground for
questioning the decision of the shareholders that the alteration was for
the benefit of the company; and,
 the plaintiff was not entitled to the relief claimed.
ARTICLES OF ASSOCIATION
The Article of Association is the bye-laws which govern the internal
management of the company. According to Section 2 (2) of the
Companies Act, 1956,”Article means the Article of Association of a
company as originally framed or as altered from time to time in
pursuance of any previous companies law or of this Act”. It is the

subordinate to the memorandum of association. The Article of
Association can not contain anything which alters the condition of
memorandum of association. The Article of Association must not
have any conditions which are contrary to the provision of Companies
Act.
According to Lords Cairns,” The articles play a part subsidiary to the
memorandum of association. They accept the memorandum of
association as the charter of incorporation of the company and so
accepting it, the article proceed to define the duties, the rights and
powers of the governing body as between themselves and the
company themselves and the company at large and the mode and the
form in which changes in the internal regulations of the company may
from time to time be made.”
FORMS AND SIGNATURE OF ARTICLES (Sec 29 and 30):
Schedule I of the Companies Act gives certain model forms of articles
for different types companies as:
Table A, for, public companies having share capital,
Table C, for, a company limited by guarantee and not having share
capital,
Table D, for, a company limited by guarantee and having share
capital,
Table E, for, an unlimited company.
According to Section30, the Articles of Association of every company
must be printed and signed by the each subscriber. They are also the
subscribers of memorandum of association. They have to write their
addresses, descriptions and occupation if any in presence of witness
and attest the signature and shall likewise add his other details.
The Article of Association of a company should contain the following
matters:
1. Allotment of shares;
2. Fixation of minimum subscription;
3. Dividends, reserves and depreciation funds;
4. Share certificates and share warrants;
5. Directors, their qualifications, remuneration, rotation etc and
board meeting;
6. Definition of important words and phrases;

7. Specifying the different classes of share capital ;
8. Calls on shares;
9. Winding up;
10. Transfer and transmission of shares;
11. Borrowing;
12. Management;
13. Forfeiture and reduction of capital;
14. Increase and reduction of capital;
15. Consolidation and sub-division of shares;
16. Common seal;
17. Notices;
18. Arbitration;
19. Accounts and audit;
20. The exclusion, total or partial, Table A;
21. General meeting , proceedings thereof and votes, proxies and
polls;
22. Payment of underwriting commission.
Everything stated in the article of association is subject to the
Companies Act and contrary to the provision of the Act is inoperative
and void. It contains the rules which regulate the business of the
company. There are certain matters in respect of which powers can be
exercised by the company only if its articles provide.
Alteration of AOA:-
A company by special resolution can alter or add to its article of
association. This should be filed with the Registrar within 30 days, in
the printed form. The right to alter of article of association can be
done by passing special resolution. Thus, there are certain limitations
regarding alteration of article of association.
Limitations regarding alteration of article of association:
 A company cannot alter its articles so as to exclude or limit the
rights of the shareholders or inconsistent with the provisions of the
Companies Act.
 The article must not override any provision of memorandum of
association.
 It must not be inconsistent with the alteration ordered by the
Companies Law Board.

 In certain cases, the approval must be taken from the Central
Government.
 The alteration must not deprive any person of his rights under a
contract.
 The alteration should be for the benefit of the company
Limitations on power of alteration:-
A company can alter its article of association at any time by passing a
special resolution. But, a company can exercise this power subject
only to certain limitation.
1. The alteration must not contra any provision of memorandum of
association.
2. The alteration must not contra any provision of Companies Act or
any Statute.
3. The alteration must not contain anything which is illegal or oppose
to public policy.
4. The alteration must be for the benefit of the Company as a whole
5. Approval for alteration from the Central Government is also
requiring in certain cases.
6. A company cannot justify breach of contract with third parties or
avoid a contractual liability by altering article.
7. The alteration of article of association must not do by any fraud on
the minority, by the majority.
8. The alteration cannot be made unalterable.
9. The alteration of article of association should not increase the
liability of the members.
10. The alteration of article of association should be made only by
special resolution
DOCTRINE OF CONSTRUCTIVE NOTICE:-
In companies law the doctrine of constructive notice is a doctrine
where all persons dealing with a company are deemed (or
"construed") to have knowledge of the company's articles of
association and memorandum of association. The doctrine of indoor
management is an exception to this rule
DOCTRINE OF INDOOR MANAGEMENT:- It is a rule of
exception of constructive notice. Different persons dealing with a
company. They are whether shareholder or outsider is deemed to have

knowledge of the memorandum and article of association. Thus, when
a transaction appears to be proper according to the memorandum and
article of association, the company can not escape from its liability.
The doctrine had its origin in the leading case of Royal British Bank
v. Turquand.
The facts of the case are:
The directors of the bank issued a bond to Mr. Turquand. The articles
provided that the directors had the power to issue bond if authorised
by a proper resolution of the company. No such resolution was
passed. It was held that Turquand could sue on the bond as he was
entitled to assume that the resolution must have been passed. It was
observed that person dealing with the company bound to read the
registered documents and to see that the proposed dealing is not
inconsistent therewith. But they are not bound to do more; they need
not inquire into the regularity of internal proceedings.
Here the point decided is that:
The outsider’s dealing with the company are entitled to presume that
as far as the internal management of the company is concerned, every
thing has been regularly done.
Exceptions to the doctrine of indoor management:
The outsiders can not claim relief on the ground of doctrine of indoor
management in the following circumstances:
1. Knowledge of irregularity:
2. A person shall not get any relief under this doctrine, when he
knows fully that the directors do not have the authority to make the
transaction but still enter in to it.
3. Negligence:
When any officer of the company does any such act for which he is
not having power, the person dealing with him must make proper
enquiry and satisfy himself as to the officer’s authority. But, if he fails
to do so, he is not getting any relief under this rule.
3.Forgery:
The rule of doctrine of indoor management can not be invoked in
favour of transaction involving forgery or otherwise void.
4.Acts outside the apparent authority:

If any act of an officer is beyond the power of the officer, the person
entering into such transaction with him can not claim the protection of
the Rule.
5.No knowledge of the contents of articles:
The person, who has not read the memorandum and article of
association and entered into the contract, can not seek relief under this
Rule.
DIFFERENCE BETWEEN MOA & AOA
Basis for
Memorandum of Association Articles of Association
Comparison
Memorandum of Association is a Articles of Association is
document that contains all the a document containing all
Meaning fundamental information which are the rules and regulations
required for the incorporation of that governs the
the company. company.
Defined in Section 2 (28) Section 2 (2)
Type of
Powers and objects of the
Information Rules of the company.
company.
contained
It is subordinate to the Companies It is subordinate to the
Status
Act. memorandum.
The memorandum of association of The articles of
Retrospective
the company cannot be amended association can be
Effect
retrospectively. amended retrospectively.
The articles can be
A memorandum must contain six
Major contents drafted as per the choice
clauses.
of the company.
A public company
limited by shares can
Obligatory Yes, for all companies.
adopt Table A in place of
articles.
Compulsory
filing at the time Required Not required at all.
of Registration
Alteration can be done, after Alteration can be don in
passing Special Resolution (SR) in the Articles by passing
Alteration
Annual General Meeting (AGM) Special Resolution (SR)
and previous approval of Central at Annual General
Basis for
Memorandum of Association Articles of Association
Comparison
Government (CG) or Company Meeting (AGM)
Law Board (CLB) is required.
PROSPECTUS
MEANING OF PROSPECTUS: A private company can commence
business after its incorporation but a public company cannot start its
business because it has to generate capital, which is collected through
sale of shares and debentures by advertising in newspapers. For this
the public is invited. This invitation card to public is called
prospectus.
Definition “according to section 2 of the company Act 1956,
prospectus refers to that document which is issued in the form of an
invitation. Through advertisement for the purpose of inducing the
public to buy its shares or debentures, the company invites the public
with the issue of prospectus.”
OBJECTIVES OF PROSPECTUS:
1. To invite the public to buy shares or debentures.
2. To give all the relevant information and condition which are
necessary to be known by the public while buying shares or
debentures?
3. To declare that the responsibilities given to the Directors through
the prospectus are acceptable by them.
CONTENT OF PROSPECTUS:
1) History of the company: Under this heading, the brief story of the
company.
2) Objects of the company: The prospectus must contain the
objectives,policies and the estimated profitability of the company.
3) Information relating to directors and managers: The following
information are given under this head-
 Names, Addresses and details of directors and managing
Directors
 The policy adopted for their appointment, remuneration and
compensation in case of their retirement before time
 The qualification required to become a director ,as per the
articles of the company.
4) Details of Share capital: under this heading the information related
to two kinds of shares is given-
 The capital issued as authorized capital by the company and all
other kinds of Share Capital.
 Kinds of shares and number of each category of shares
 Amount of Minimum Subscription
5) Information about promoters: Under this, the amount of
remuneration paid to the promoters, for their services must be
mentioned the details of promoters in the company etc must to be
mentioned.
6) Information about auditors: It is necessary to give the names,
address and fees etc of the auditors in the prospectus.
7) Information about Underwriters: If the shares of the company are
underwritten, then the names of underwritten by them and the details
of those amount should be given in the prospectus.
8) Details of financial planning: under this, the details of the total
capital of the company and means of its collection and the contracts
entered into with the financial organization etc. should be mentioned.
9) Details of Important Contracts: Under this, the details of all the
important contracts of the company should be given ,sothat the
shareholders also get information about the kinds of contract entered
into by the company
STATEMENT IN LIEU OF A PROSPECTUS
A public limited company, 1. which has not issued a
prospectus.2.which has issued a prospectus, but has not proceeded to
allot any of the shares, offered to the public for subscription, is
required to deliver to Registrar a “statement in lieu of prospectus” for
registration, at least three days before the allotment of shares or
debentures.
Schedule III contains the details of the particulars to be
furnished. In case of private company becoming a public company,
statement in lieu of the prospectus can be filed. Schedule IV contains
the details of the particulars to be furnished for the same.
Such a statement is required to be signed by every person,
who is named therein as a director or a proposed director, of the
company, or by his agent authorized in writing.
If allotment of shares or debentures is made without filing the
statements in lieu of prospectus, the allotted may avoid it within two
months after the statutory meeting, or where no such meeting is to be
held, within two months of the allotment. Contravention also renders
the company and every director liable to fine up to rupees 10,000.
GOLDEN RULE OF FRAMING A PROSPECTUS:-
The golden rule while framing the prospectus that must be observed
was laid down by KINDERSELY VC in New Brunswick and Canada
Rly and Land Co v Muggeridge. In brief the rule says that since the
public is invited to take shares on the faith of the representations
made in the prospectus, everything must be stated with strict and
scrupulous accuracy. The public is at the mercy of the company
promoters, hence nothing should be stated as fact which is not so, and
no fact should be omitted the existence of which might in any degree
affect the nature or quality of the privileges and advantages which
acted as an inducement to take shares. Thus the true nature of the
company’s venture should be disclosed.
MISSTATEMENT:
As per Sec-65, a statement included in a prospectus shall be deemed
to be untrue if the statement is misleading in the form and context in
which it is included. Where there is any omission of a matter from the
prospectus and this is made to mislead, the prospectus is deemed to be
called as a prospectus in which an untrue statement is included. Not
only in prospectus, but a statement can be said to mislead even if it is
present in any report or memorandum by reference incorporated
therein or issued therewith. The liability accrues where any person
subscribes for any shares or debentures on the faith of the prospectus
for any loss or damage he may have sustained by reason of untrue
statement included therein.
CASE: DERRY vs. PEEK
The directors of a tramway company issued a prospectus stating that
they had the right to run tram cars with steam power instead of with
horses as before. The Act incorporating the company provided that
such power might be used with the sanction of the Board of Trade.
But, the Board of Trade refused to give permission and the company
had to be wound up. One of the shareholders sued the directors for

damages for fraud. Now, the House of Lords held that the directors
were not liable in fraud because they honestly believed what they said
in the prospectus to be true. Lord Herschel in this case observed that
“Fraud is proved when it is shown that false representation has been
made (a) knowingly, (b) without belief in its truth, or, (c) recklessly,
carelessly whether it be false or true.
CIVIL LIABILITY FOR MISSTATEMENT:
Section 62 of the Companies Act, 1956 makes certain person liable to
pay compensation to every person who subscribes for any shares of
debentures on the faith of the prospectus for any loss or damage he
may have suffered due to any untrue statement made in the
prospectus. These would include Directors of the company,
Promoters, or even the company. Thus, this section deals with the
cases of misstatements of facts in a prospectus. It is immaterial for the
purpose of this section whether the Director sees the prospectus or
not; it is enough that he authorizes its issue.
The provision of the section is to protect the rights of the deceived
shareholders who acted upon the wrong statement given in the
prospectus. This tightens up the duties of the directors and others who
are related to the issue of the prospectus. So this section provides for
the statutory civil liability for untrue statement.
Conditions for invoking Section 62:
1) The company had issued a prospectus inviting persons to
subscribe for its shares or debentures.
2) An untrue statement was included in the prospectus.
3) The person who is claiming for the compensation had
subscribed for the shares or debentures offered by the prospectus.
4) Such person has subscribed for the shares or debentures relying
upon the untrue statement contained in the prospectus.
5) Such person has sustained a loss or damage after having
subscribed for the shares or debentures.
Persons liable under Sec- 62:
Every person who is a director of the company at the time of the issue
of the prospectus;

every person who has authorised himself to be named and is named in
the prospectus as the director or agreed to become a director, either
immediately or after an interval of time;
every person who is a promoter of the company;
every person who has authorised the issue of the prospectus
CASE: Edington vs. Fitzmaurice
A company issued a prospectus inviting subscriptions for debentures.
The prospectus contained a statement that “the objects of the issue of
debentures are (a) to complete alterations in the buildings of the co.,
(b) to purchase horses and vans and, (c) to develop the trade of the
co.” However, the real object raised by debenture was to payoff the
liabilities. Relying upon the statement in the prospectus, a person
advanced money to the co. and purchased its debentures. The co.
became insolvent, and that person filed a suit against the directors for
fraud . It was held that the directors were liable for fraud. Here, the
statement made was of existing fact as the director has misrepresented
their state of mind and the statement made in the prospectus was
material to the contract of purchasing debentures.
Here, the Court is right in judging the case as the object of the
debentures mentioned in the prospectus is totally contradictory to the
actual purpose. The company is rightly liable for fraud.
CRIMINAL LIABILITY:
Sec-63 incorporates the provision for the criminal liability for
misstatement in the prospectus. According to this section every
person who has authorised the issue of the prospectus shall be
punishable with imprisonment for a term which may extend to two
years, or with fine which may extend to fifty thousand rupees, or with
both. The offence is compoundable under sec 621A. It has to be noted
that under such cases, once the prosecution establishes the falsity of
statement in a prospectus signed by a director, etc., the onus is shifted
to the defendant of proving either that the statement was immaterial or
that he believed it to be true. An expert who has given the consent
will not be deemed to be ipso facto a person who authorized the issue
of prospectus.

DEFENCE IN CASE OF GENERAL LIABILITY:
A director or other person responsible for the prospectus shall not
incur any liability for non compliance with any of the requirements of
the prospectus if
he proves that he had no knowledge of the matter not disclosed in the
prospectus
he proves that the non-compliance or contravention arose from an
honest mistake of fact on his part; or
the non-compliance or contravention was in respect of matters which,
in the opinion of the Court dealing with the case were immaterial or
was otherwise such as ought, in the opinion of that court, having
regard to all the circumstances of the case, reasonably to be excused,
provided that no director or other person shall incur any liability in
respect of the failure to include in a prospectus a statement with
respect to the matters specified in clause 18 of Schedule II unless it is
proved that he had knowledge of the matters not disclosed
DEFENCE AVAILABLE TO ANY PERSON OTHER THAN
EXPERT IN CIVIL LIABILITY:
Withdrawal of consent: A director will not be liable if he withdraws
his consent to be the director and the prospectus is issued without his
consent and authority.
Issue without knowledge: Even where the name of the director
appears in the prospectus he can escape from the liability by stating
that it was issued without his knowledge and after becoming aware of
it he gave a public notice to that effect.
Ignorance of untrue statement: A director may be ignorant of a
statement made in the prospectus as false. In such case the director
can use a defence that after becoming aware of the untrue statement,
he withdrew his consent by a reasonable public notice. But this must
be done before allotment.
Reasonable ground for belief: A director will also be protected if he
shows that he had reasonable ground to believe and the time of
allotment he believed it to be true.
DEFENCE AVAILABLE TO AN EXPERT:
An expert who has given his consent under sec – 58 of the act would
not be liable if he proves :

after giving his consent to the issue of the prospectus, he withdrew it
in writing before delivery of a copy of the prospectus for registration ;
On becoming aware of the untrue statement after delivery of a copy
for registration and before allotment, he withdraws his consent in
writing and gives reasonable public notice to the public and reasons
for the same;
that he was competent to make the statement and that he had
reasonable ground to believe, and did up to the time of the allotment
of the shares or debentures, believe that the statement was true.
DEFENCE IN CASE OF CRIMINAL LIABILITY:
Any person who could he held criminally liable shall not be deemed
to be so if he proves either that the statement was immaterial or that
he had reasonable ground to believe, and did up to the time of the
issue of the prospectus believe, that the statement was true.
CONCLUSION:
Every person authorizing the issue of prospectus has a primary
responsibility to see that the prospectus contains the true state of
affairs of the company and does not give any fraudulent picture the
public. The section 62 makes certain person liable to pay
compensation to every person who subscribes for any loss incurred
who subscribes the shares or debentures on the faith of the prospectus.
But there are also some defences available to the persons held liable
for the misstatement and they can evade the consequences if the
conditions are satisfied. Hence it is clear that ever one is held liable to
the shareholders if any wrong is committed by the company or any
person working on behalf of the company. Law leaves no one if the
wrong is proved against them
MEETINGS
A company is a artificial person created by law and destroyed by law.
it has to take various decisions for the working of the company and
these decisions are taken by the natural persons who are called as
shareholders. These decisions are taken in properly convened meeting
of the shareholders , their elected representative and directors.
Definition:-

According to a dictionary meaning:-“ A meeting is a gathering or a
assembly of a number of persons for purposes of intercourse,
entertainment, discussion or the like.”
In other words , when two or more persons comes together to
discuss matters of common interest, there is said to be a meeting
Types of meetings:-
A. Meetings of the members.
B. Meetings of the Directors.
C. Meeting of the creditors and debenture holders.
(A) Meetings of the members:- It can be of two types:-
1) General meetings of the members
2) Class meetings of the members
General meetings of the members:- It includes following types of
meetings:-
a) Statutory meeting
b) Annual general meeting
c) Extraordinary general meeting
(a) STATUTORY MEETING (Section 165)
Statutory Meeting is the first meeting of the shareholders of a
company. It is called statutory because it is essential to call this
meeting within a specified time and this meeting is held only once in
the life time of the company. The following companies shall have to
call their statutory meeting:-
(I) Public company limited by shares.
(II) Public company limited by guarantee having share capital.
(III) Private company which become a public company by the
application of section 43.
The following companies are not required to hold a statutory
meeting:-
(I) Private companies.
(II) Public companies limited by guarantee not having share capital
and
(III) Unlimited companies.
The main objectives of calling a statutory meeting of the company are
:-

1) To approve the preliminary contracts specified in the prospectus
of the company with modification if any.
2) To discuss the success of floating the project of the company.
Provisions for Holding Statutory Meeting
Following are the essential provisions for calling and holding
statutory meeting of the company :-
1. Time:- Every company, shall, within a period of not less than
one month and not more than six months from the date on which the
company is entitled to commence business, hold a general meeting of
its shareholders which is called statutory meeting.
2. Notice :- The company must give notice to its members at least
21 clear days before holding the statutory meeting stating time, date
and place of meeting. However ,(if the members holding 95% of the
paid up share capital voting rights gives their consent, meeting can be
called at a shorter notice.)
3. Statutory Report :- The Directors of the company are required
to send a report called “Statutory Report” to every member of the
company along with the notice of the meeting at least 21 days before
the date of meeting. A statutory report shall have the following
contents :-
1) Allotment of Shares :- The total number of share allotted,
distinguishing fully paid or partly paid-up and the extent to which
they are so paid-up, shares issued otherwise than for cash.
2) Case Received :- Total amount of cash received by the
company in respect of all the shares allotted.
3) Abstract of Receipt and payment Account :- An abstract of
receipts of the company and that of payments made by the company
up to a date shall be given.
4) Directors Auditors and other Managerial personnel:- The
names, addresses and occupations of its directors, auditors and all
other Managerial personnel shall be given.
5) Preliminary contracts :- The particulars of any preliminary
contracts and the proposed modification which are to be submitted for
approval.
6) Underwriting contracts :- The extent to which the under
writing contracts has not been carried out and the reasons thereof.

7) Calls in arrears from Directors and Managers :- The calls
in arrears, if any, due from any Director and the managers of the
company.
8) Commission and Brokerage :- Any commission or brokerage
paid to any director or manager on the issue of Shares or debentures
of the company.
4. Certification of Statutory Report :- The statutory Report Shall
be certified as correct by not less than two Directors of the company,
one of whom shall be the managing Director, if any . The auditor of
the company shall certify the particulars regarding shares allotted,
cash received, and receipt & payment account. A certified copy of the
statutory report shall be sent to the registrars for registration
immediately after it is sent to the members of the company.
5. Procedure of the meeting :- At the commencement of the
meeting, the Board of Directors shall place a list showing the names,
addresses and occupation of the numbers of the company and the
number of shares held by them. The list shall remain open for
inspection by the member during the meeting. The members shall be
free to discuss any matter with respect to formation of the company or
arising out of the statutory report of the company.
6. Penalty :- If default is made in complying with the provisions
of section 165, every director and officer of the company shall be
liable to a fine which may extend to Rs.5000 if default is made in
delivering the “Statutory Report” to the Registrar, or in holding the
Statutory meeting the company may be wound up by the court.
However, court may give directions for the statutory report to be filed
or a statutory meeting to held, as the case may be and refuse to order
the winding up of the company.
(b) ANNUAL GENERAL MEETING (Section 166)
Every company must hold a general meeting of its
shareholders in each calendar year in any other meeting as its
annual general meeting. A calendar year means from 1 st December
every year. It is called annual General meeting, because it is held
every year.
Objective of Holding the Annual General Meeting

1. Presentation Of Annual Account:- The profit & Loss Account
and Balance Sheet of the company shall be presented by the Board of
Director for the approval of the shareholders.
2. Declaration of Dividend : Directors may also declare Dividend
for the shareholder of the company, if they think so.
3. Appointment of Auditors:- Auditors of the company for the
next year financial year are also appointed, and their remuneration
shall also be fixed in the annual general meeting.
4. Appointment of Directors in place of retiring by rotation:

In case of public companies limited by share 2/3rd number of Director
shall retire by rotation and new Directors in their place shall be
appointed in the annual General Meeting of the shareholders. Howe
ever retiring Director can also present themselves for re-appointment
as they are eligible to be appointed.
5. Special Business: Any other business can also be conducted at
the Annual General Meeting of the company which can be specified
in the clause as they are eligible to be appointed.
Provisions for holding Annual General Meeting
1. First Annual General Meeting:- First Annual General
Meeting of the company should be held within a maximum period of
18 months from the date of its incorporation.
2. Subsequent Annual General Meetings:- Thereafter this
meeting should be held every year and that should be one meeting per
year and as many meetings as there year. There cannot be a gape of
more than 15 Months between dates of two Annual General Meeting
of Company. Register may extend the time for holding an Annual
General Meeting by period not exciding 3 Months for any special
reason. But no extension is granted for holding the 1 st Annual General
Meeting.
3. Power to convene the Annual General Meeting :- Only
Board of Directors of company has the power to convene the Annual
General meeting of the company. No individual Director, secretary or
even general Director can convene the Meeting.
4. Notices:- A public company must given 21 clear days notice to
all member to convene the Annual General Meeting of the company

However, if all the members having voting rights given the consent,
the meeting can be called at shorter notice. Holding of Annual
General meeting is a statutory requirement. The plea that a company
did not function in a year shall be no excuse for not holding the
Annual General Meeting of the company.
5. Date time and Place of holding Annual general Meeting:-
Every Annual General meeting shall be called during the business
hours, on a day which is not a public holiday, and shall be either at the
registered office of the company or at some ot place within the city
which the registered office off company, is situated. Business hours
means the normal work hours of company. The meeting must start
within the business hours and there is no restriction on the duration of
the meeting and therefore it may last beyond business hours of
company.
6. Postponement :- Where an Annual General Meeting is
convened for a particular date and notice is issued to the members, the
board of Director may cancel or postpone an Annual General
Meeting, provided the it is being done for bonafide reason.
7. Adjournment:- An Annual General meeting can be adjourned
by the Chairman for confide reasons only. If a Chairman does so
wrong fully, members may appoint a new chairman and according
procedure with meeting. If the meeting is adjourned it shall be
counted as a separate meeting. Where the meeting adjourned, the
adjourned meeting shall be held on the same day next week at the
same place at same time.
8. Power of the Company law board to call Annual General
Meeting:- Where a company fails to hold its Annual General meeting
within the prescribed deride of time the Company Law board on the
application of any member , may either call or direct the company to
call its annual general meeting. The company Law Board may direct
that one member of the company present in person or by proxy shall
be annual general meeting of the company. (Section 167).
9. Penalty:- If default is made in complying with the provisions
of section 166 the company and other officer of the company who is
in default, shall be punishable with a fine which may extend to

Rs.50,000 and if the default continues, with a further fine of Rs.2500
per day till the default continues.
10. Annual general meeting when Annual Account are not
ready:- When the Annual accounts are not ready to be presented
before the annual general meeting of the company, there is a clear
statutory duty on the Directors to call the meeting, whether or not the
account are ready. The proper course to follow is to hold the meeting
within prescribed period, Transact all business except the presentation
of the accounts and then to adjourn the meeting to some future data
when the accounts will be ready to be placed before the shareholder
of the company.
(c) EXTRA ORDINNARY GENERAL MEETING
Any general meeting other than an annual general meeting is called an
Extra-ordinary general meeting. A statutory meeting and annual
general meeting of a company are called ordinary meetings.
Objectives of holding the Extra Ordinary General Meeting:- An
Extra ordinary general meeting of a company is called for transaction
some urgent or special business of the company for which it is not
advisable to wait till the next annual general meeting of the company.
Therefore this meeting is generally held for the purpose of dialing
with any extra-ordinary matter which cannot be postponed till the
next annual general meeting of the company. Hence, extra-ordinary
General meeting is a meeting which is held between two consecutive
annual general meetings.
.Who can convene an Extra-ordinary general Meeting:-
An Extra-ordinary general Meeting can be convened:-
1- By the board of Directors, or
2- By the requisitionists ,or
3- By the tribunal
1. Extra-ordinary General Meeting convened by the Board of
Directors:-
The Board of Directors may call Extra-ordinary meeting of the
company:-
(1) On their own, or
(2) On the requisition of Members.
(3) EGM convened by the requisitionists.

(4) EGM convened by the tribunal.
(1) On their own:-
Board of Directors may convene an Extra-ordinary general
Meeting of the company as and when they think fit by passing a
resolution at the board meeting.
(2) On the requisition of Members :-The Directors shall have to call
an Extra-ordinary General Meeting of the company if a requisition is
made and signed by-
(a) In the case of companies having share capital, the holder of
at least 10% of paid up share capital of the company carrying voting
rights, OR
(b) In the case of companies not having any share capital,
representing at least 10% of the total voting right in case the company
does not have share capital.
Provisions to hold this meeting:-
(i) The board of Directors must proceed to call it’s Extra-
ordinary General meeting within 21 days of the receipt of the valid
requisition.
(ii) The Board of Directors shall send out notices to all the
members of company giving not less than 21 clear days to meeting.
(iii) The meeting must be held within 45 days from the date of
deposit of the requisition.
(3.) Extra-ordinary General Meeting convened by the
Requisitionists:- Where a valid requisition signed by the required
number of members was deposited with the company to call it’s
Extra-ordinary General Meeting of the company and the board of
directors fails to the call the meeting within 21 days from the deposit
of required fee, the meeting may be called ,
a) By the requisitionists themselves : -
b) In the case of companies having share capital, the holder of at
least 10% of the paid up share capital of the company carrying voting
right ,OR
c) In the case of companies not having any share capital,
representing at Least 10% of total voting rights in case the company
does not have Share capital.
Rules regarding holding of meting by the requisitionists:-

a) This meeting must be called by the requisitioned within the
period of 3 months from the date of deposit of the requisition by the
Requisitionists.
b) Ordinarily this meeting should also be held in the same
manner as if it is called by the board of directors. The member must
as served with a notice of 21 clear days. And the meeting should be
called at the registered office of the company. But where the
companies do not provide its registered office to be used by the
requisitionists to hold the meeting, this meeting can be held at some
other place.
c) All expenses to hold this meeting by the requisitionists shall
be born by the company and the requinisitionists can recover the
expenses from the company.
d) All the resolution duly passed by the shareholder shall be
binding on the company in same manner as if the meeting had been
called by the Board of Directors of the company.
(4)EGM convened by the Tribunal (Section 186):- If for any reason
it is impractical for a company to call or hold or conduct an EGM the
Tribunal may call an EGM
 At its own
 On the application of any director of the company.
 On the request of any member of the company who is
entitle to vote at the meeting.
2. Class meeting:-The class meetings are generally held to obtain
the consent of particular class of shareholders for altering their rights
and privileges or for the conversion of one class into other. the articles
of association of a company so provides that the rights of different
classes of shareholders can be altered only by passing a resolution at a
separate meeting of holder of that class of shareholders.
REQUISITES OF A VALID MEETING
A general meeting of the shareholders of the company must be called
and held in the manner which is provided in Article of Association of
the company and must follow the procedure laid down in the Indian
Companies Act, 1956. Any irregularity in procedure can invalidate
the meeting of the company. To validate the proceeding of a general
meeting the following requirements must be satisfied─
1. Meeting must be convened by proper authority.
2. Members are served with proper notice.
3. Quorum must be present.
4. Chairman must preside.
5. Minutes must be recorded.
1. Meeting must be convened by proper authority:-
The proper authority to convene the general meeting of the
shareholders of the company is the Board of Directors of the
company, who should pass a special resolution to call the meeting at a
dully convened meeting of the Board. A sole Director or the Secretary
of the company has no authority to call the meeting. Under some
circumstances if the Board of Directors do not call the meeting, the
members of the company (Requisitionists) or the Company Law
Board may also call the meeting. Minor irregularity does not result
into invalid meeting.
2. Members are served with proper notice:-
The second important requirement of a valid meeting is that a proper
notice of the meeting should be given to all the members of the
company. All the members of the company are entitled to attend the
general meeting of the company, therefore all the members must get a
notice the meeting. The notice must be given for at least 21 clear days
before each scheduled meeting. Clear days means the period of 21
excluded the date of the service of the notice and the day on which
the meeting is to be held.
A meeting may be cancelled by a notice of less than 21 days under the
following circumstances:-
1. Annual General Meeting:-
In case of annual general meeting if all the member of the company
entitled to vote agree, the meeting can be cancelled a shorter notice.
2. Statutory Meeting and Extra- Ordinary General Meeting:-
In case all other meeting i.e., Statutory meeting and Extraordinary
general meeting, if the member holding 95 percent paid up share
capital having voting rights gives? Consent, the meeting can be
called at a shorter notice.
Contents of Notice:-Every notice of a meeting a company must
contain the following information:-

(i) The date of the meeting.
(ii) The place of the meeting.
(iii)The day and hour of the meeting.
(iv) Agenda of meeting, i.e., A statement of business to be transacted
at the meeting at the meeting. The business to be conducted must be
clearly mentioned as ordinary business and special business in the
case of Annual General Meeting.
(A) Ordinary Business:-
In the case of Annual General Meeting, the business relating to the
following items is deemed as ordinary of the company:-
(1) Presentation of Annual Accounts :-The Profit & Loss
Account and Balance Sheet of the company shall be presented by the
Board of Directors for the approval of the shareholders.
(2) Declaration of Dividend:-Directors may also declare dividend
for the shareholders of the company, if they think so.
(3) Appointments of Auditors :- Auditors of the company for the
next financial year are also appointed, and their remuneration shall be
fixed in Annual General Meeting.
(4) Appointment of Directors in place of the Directors retiring
by rotation: In case of public companies limited by shares 2/3rd
number of Directors shall retire by rotation and new Directors in their
place shall be appointed in the Annual General Meeting. However
retiring Directors can also present themselves for re- appointment as
they are eligible to be re- appointed.
(B) Special Business:-
Any business other than ordinary business is deemed special. Any
other business can also be conducted at the annual general meeting of
the company which can be specified in this clause of special business.
3. Quorum must be present
(i) Quorum must the minimum number of member who must be
present in other to constitute a valid meeting and transact the business
of the company
(ii) Where the quorum is not present in any meeting of the
company there is no Meeting and the proceeding held in such a
meeting are not valid and they are not binding on the company .The
quorum is generally fixed in the articles of association of company.

Where the articles of the company do not provide for a larger quorum,
the quorum shall be as under:-
(i) Public Companies :- In case of a public company 5
members personally present shall be the quorum of the meeting.
(ii) Private companies or deemed public companies:- In the
case of Private companies or deemed public companies 2 members
personally present shall be the quorum of the meeting
Rules Regarding Quorum:-
Where nothing is written in the Articles of Association of the
company, the following rules shall apply:-
(a) If within half an hour the quorum is not present the meeting
shall be :-
(i)Adjourned to the same day in day in the next week at the same
time and place, if the meeting was called by the Board of Director or
the company Law board.
(ii)Dissolved if the meeting was called upon requisition by the
members.
(b) If at the adjourned meeting also the quorum is not present within
half an hour the member present shall de the quorum.
The articles cannot provide for a smaller quorum than the
statutory minimum limit under the act .For the purposes of quorum
only member present personally shall counted and the persons present
in proxy are not to be counted .However a company may by its
articles for Proxies to be counted for quorum.
One member may constitute a valid meeting:-
One member personally or by proxy may constitute a valid meeting
under the following circumstances:-
(I) Where the quorum is not present at an adjourned meeting
within half an hour the members present shall be quorum.
(II) Where the general meeting is called by company law board
section 167 ,it may direct that even one member present in proxy
constitute quorum.
(iii) Where the company law board orders on extra –ordinary
general meeting of the company to be held, it may direct that even
one the member present in person or proxy shall be the quorum.
4. Chairman of the meeting:-

A chairman is necessary to conduct a meeting of the shareholders.
Where nothing is provided in the Articles of the company, the
members present at the meeting should elect one of them to be the
chairman of meeting on a show of hands. If a poll is demanded on the
election on the show of hands shall conduct the poll and if some other
person is elected as chairman, the new chairman shall take over the
rest of meeting.
5. Minutes must be recorded:-
Every company must keep a record of all proceedings of every
general meeting .This is done by making entries of the proceedings in
the books kept for this purpose within 30 days of the conclusion of
every such meeting. These records are known as minutes and the
books in which recorded are called minute books. The pages of the
minute book are consecutively numbered. No page should be pasted
or discarded from a minute book in any case .Each page of the minute
book should be signed by the chairman of the meeting.
DIRECTORS
A director may be defined as an individual who directs, controls or
manages the affairs of the Company.A director is a person who is
appointed to perform the duties and functions of a company in
accordance with the provisions of The Company Act, 2013. They are
comparatively known as Board of Directors.
Every Company shall have a Board of Directors consisting of
Individuals as director.
They play a very important role in managing the business and other
affairs of Company. Appointment of Directors is very crucial for the
growth and management of Company. Every Company shall have a
Board of Directors consisting of Individual as director.
Appointment of Directors under Companies Act 2013
Generally, in a public company or a private company subsidiary of a
public company, two-thirds of the total numbers of Directors are
appointed by the shareholders and the remaining one-third’s
appointment is made as per Articles and failing which, shareholders
shall appoint the remaining one-third. In a private company, which is
not a subsidiary of a public company, the Articles can prescribe the

manner of appointment of any or all the Directors. In case the Articles
are silent, the Directors must be appointed by the shareholders.
The Companies Act also permits the Articles to provide for the
appointment of two-thirds of the Directors according to the principle
of proportional representation, if so adopted by the company in
question.
Nominee Directors can be appointed by a third party or by the Central
Government in the case of oppression or mismanagement.
A Minimum Number of Directors Required in Company
1. Minimum two directors in case of Private Limited Company.
2. Minimum three directors in case of Public Limited Company.
3. In the case of one person Company minimum one director.
4. Maximum 15 directors any Company shall have If Company
wants to have more than 15 directors necessary approvals is required
under the law.
Further, every Company should have one Resident Director (i.e a
person who has lived at least 182 days in India in the previous
calendar year.)
Director’s appointment is covered under section 152 of Companies
Act, 2013, along with Rule 8 of the Companies (Appointment and
Qualification of Directors) Rules, 2014.
Qualifications for Directors
The Companies Act does not prescribe any qualifications for
Directors of any company. An Indian company may, therefore, in its
Articles, stipulated qualifications for Directors. The Companies Act
does, however, limit the specified share qualification of Directors
which can be prescribed by a public company or a private company
that is a subsidiary of a public company, to be five thousand rupees
(Rs. 5,000/-).
Following documents are required for appointment of a person as
Director;
1. Apply for DSC: In India, The appointment of directors can be
only done thru the digital signature and so 1st step is to create DSC.
2. Apply for DSC: That’s the mandatory requirement for
becoming a director of a Company. A person must have DIN i.e.

Director Identification Number which can be obtained online by filing
DIR -3 on MCA.
3. Documentation Preparation: A letter in writing stating his
consent as Director; A letter in writing to the effect that the person is
not disqualified to be appointed as Director as specified under Law;
Disclosure of Interest in Other Companies (shareholding pattern); if
any, else a NIL disclosure is sufficient.
Notice to call Board meeting with Explanatory Statement. Resolution
to be passed at the meeting for the appointment of a director.
Appointment letter to be issued by Company to a director for its
appointment.
4. Filing of Form DIR-12: E-form DIR-12 with ROC along with
above-mentioned documents such as consent / Approval letter, DIR-
2, and notice and certified copy of a resolution of Meeting. Form to be
filed within 30 days.
New Categories of Director
Resident Director:
This is one of the most important changes made in the new regime,
particularly in respect of the appointment of Directors under section
149 of the Companies Act, 2013. It states that every Company should
have at least one resident Director i.e. a person who has stayed in
India for not less than 182 days in the previous calendar year.
Woman Director:
Now the legislature has made mandatory for certain class of the
company to appoint women as director. As per section 149, prescribes
for the certain class of the company their women strength in the board
should not be less than 1/3. Such companies either listed company
and any public company having-
1. paid up capital of Rs. 100 cr. or more, or
2. turnover of Rs. 300 cr. or more.
Restrictions on the number of Directorships
The Companies Act prevents a Director from being a Director, at the
same time, in more than fifteen (15) companies. For the purposes of
establishing this maximum number of companies in which a person
can be a Director, the following companies are excluded:
1. A “pure” private company;

2. An association not carrying on its business for profit, or one that
prohibits the payment of any dividends; and
3. A company in which he or she is only appointed as an Alternate
Director.
Failure of the Director to comply with these regulations will result in
a fine of fifty thousand rupees (Rs. 50,000/-) for every company that
he or she is a Director of, after the first fifteen (15) so determined.

MBA 2018
SUBJECT NAME:
MARKETING MANAGEMENT

MBA 203-18 Marketing Management
Unit –I
Understanding Marketing and Consumers: Introduction to Marketing
Management. Definition, Importance, Scope, Basic Marketing Concepts,
Marketing Mix, Marketing vs Selling, Customer Value, techniques and
relevance. Marketing Environment and Competition: Analyzing Marketing
Environment-Micro, Macro, Impact of environment on marketing. Corporate
Strategic Planning: Defining role of marketing strategies, marketing planning
process. Marketing Information System: Concept and Components. Consumer
Behaviour: Consumer buying process, Factors Influencing Consumer Buying
Behaviour,
Unit –II
Market Segmentation & Targeting: Product differentiation, Positioning for
competitive advantage, Product Decisions: Product Mix, Packaging and
Labelling Decisions, Branding, Brand value & Brand Equity. New Product
Development, Consumer Adoption Process, Product Life Cycle and marketing
mix strategies. Services Marketing and 7Ps framework. Pricing Decisions:
Objectives, Factors Affecting Pricing Decisions, Pricing Methods, Price
Changes, Pricing Strategies.
Unit –III
Delivering and Promoting Product: Supply Chain Decisions Nature, Types,
Channel Design and Channel Management Decisions, Retailing, Wholesaling,
Personal Selling: Personal Selling Process, Managing the Sales Force.
Promotion Mix: Advertising, Sales Promotion, Public Relations. Emerging
Trends in Marketing: Green Marketing, Event Marketing, Network Marketing,
Social Marketing, Buzz Marketing/ Viral Marketing, Customer Relationship
Management (CRM), Global Marketing, Rural Marketing, E-Commerce:
Marketing In The Digital Age.
Unit -IV
Bottom of Pyramid Marketing: Understanding poverty and the Base of the
Pyramid, understanding the BoP consumer: their basic needs wants and
demands, Design-Develop-Distribute approach towards BoP. Consumption and
marketing practices in BoP contexts: few challenges-The institutional context of
BoPmarkets.-Conducting Marketing Research in BoP Markets-BoP Consumers
and Producers-Producers and Entrepreneurs at the BoP. Concept of Informal
Economy-Alternative Market initiatives at BoP-Ethical issues associated with BoP.
Suggested Readings:

Unit 1
Marketing is a widely used term to describe the means of
communication between the company and the consumer audience.
Marketing is the adaptation of the commercial activities and use of
institutions by the organizations with a purpose to induce behavioural
change on a short-term or permanent basis. techniques used in
marketing include choosing target markets through market analysis
and market segmentation, as well as understanding methods of
influence on the consumer behaviour. The marketing planning creates
strategies for the company to place advertising to the dedicated
consumer. From a societal point of view, marketing provides the link
between a society's material requirements and its economic patterns of
response. This way marketing satisfies these needs and wants through
the development of exchange processes and the building of long-term
relationships. In the case of non-profit organization marketing, the
aim is to increase the deliver an ethos message about the
organization's services to the applicable audience. Governments often
employ marketing to communicate messages with a social purpose,
such as a public health or safety message, to citizens.
Definition of marketing: Marketing is the activity, set of institutions,
and processes for creating, communicating, delivering, and
exchanging offerings that have value for customers, clients, partners,
and society at large. - American Marketing Association
According to Philip Kotler, “The term Marketing is defined as a
social and managerial process by which individuals and groups obtain
what they need and want through creating, offering and exchanging
products of value with others” is known as Marketing.
Need , Want and Demand concept in Marketing:
Need: it refer to the basic necessities of human being related to their
inherent characters. e.g. food.
Wants: it refers to the desire for particular things which are unified
with the need of the individual.
Demand: demands are those definite wants for any products which are
supported by the willingness and ability to buy them.
Importance of marketing:

1. Marketing Acts as a Basis for Making Decisions:A businessman
is confronted with many problems in the form of what, how, when,
how much and for whom to produce? In the past problems was less on
account of local markets. There was a direct link between producer
and consumer.In modern times marketing has become a very complex
and tedious task. Marketing has emerged as new specialized activity
along with production.As a result, producers are depending largely on
the mechanism of marketing, to decide what to produce and sell. With
the help of marketing techniques a producer can regulate his
production accordingly.
2. Marketing Acts as a Source of New Ideas:The concept of
marketing is a dynamic concept. It has changed altogether with the
passage of time. Such changes have far reaching effects on production
and distribution. With the rapid change in tastes and preference of
people, (1) Marketing Helps in Transfer, Exchange and Movement of
Goods: Marketing is very helpful in transfer, exchange and movement
of goods. Goods and services are made available to customers through
various intermediaries’ viz., wholesalers and retailers etc. Marketing
is helpful to both producers and consumers. To the former, it tells
about the specific needs and preferences of consumers and to the
latter about the products that manufacturers can offer. According to
Prof. Haney Hansen “Marketing involves the design of the products
acceptable to the consumers and the conduct of those activities which
facilitate the transfer of ownership between seller and buyer.”
3. Marketing Is Helpful In Raising And Maintaining The Standard
Of Living Of The Community: Marketing is above all the giving of a
standard of living to the community. Paul Mazur states, “Marketing is
the delivery of standard of living”. Professor Malcolm McNair has
further added that “Marketing is the creation and delivery of standard
of living to the society”. By making available the uninterrupted
supply of goods and services to consumers at a reasonable price,
marketing has played an important role in raising and maintaining
living standards of the community. Community comprises of three
classes of people i.e., rich, middle and poor. Everything which is used
by these different classes of people is supplied by marketing. In the
modern times, with the emergence of latest marketing techniques

even the poorer sections of society have attained a reasonable level of
living standard. This is basically due to large scale production and
lesser prices of commodities and services. Marketing has in fact,
revolutionized and modernized the living standard of people in
modern times.
4. Marketing Creates Employment:Marketing is complex
mechanism involving many people in one form or the other. The
major marketing functions are buying, selling, financing, transport,
warehousing, risk bearing and standardization, etc. In each such
function different activities are performed by a large number of
individuals and bodies.Thus, marketing gives employment to many
people. It is estimated that about 40% of total population is directly or
indirectly dependent upon marketing. In the modern era of large scale
production and industrialization, role of marketing has widened.This
enlarged role of marketing has created many employment
opportunities for people. Converse, Huegy and Mitchell have rightly
pointed out that “In order to have continuous production, there must
be continuous marketing, only then employment can be sustained and
high level of business activity can be continued”.
5. Marketing as a Source of Income and Revenue: The
performance of marketing function is all important, because it is the
only way through which the concern could generate revenue or
income and bring in profits. Buskirk has pointed out that, “Any
activity connected with obtaining income is a marketing action.
Marketing does provide many opportunities to earn profits in the
process of buying an marketing has to come up with the
same.Marketing as an instrument of measurement, gives scope for
understanding this new demand pattern and thereby produce and
make available the goods accordingly.
6. Marketing Is Helpful In Development Of An Economy:Adam
Smith has remarked that “nothing happens in our country until
somebody sells something”. Marketing is the kingpin that sets the
economy revolving. The marketingorganization, more scientifically
organized, makes the economy strong and stable,the lesser the stress
on the marketing function, the weaker will be the economy.

Scope of marketing management: The scope of marketing really is
related to the old and new concept of ‘marketing’. Formerly the scope
of marketing used to remain very much limited since the wants of the
consumers too were quite limited. The competition was almost
equivalent to nil. In the marketing, the satisfaction of the consumers
was not at all considered. The marketing was commodity based and
immediately after the sale of the products, the marketing process was
over. Nowadays, the scope of marketing has become quite extensive,
and the satisfaction of the customers too is kept in view. The process
of marketing continues even after the sales have been affected. Today,
the function of conforming the product, in accordance with the
changing wants, habits and fashions of people, is undertaken by the
process of marketing. Within the scope of marketing, -the following
activities are covered:
Decisions and Researches Pertaining to Customers. Now-a-days, the
customer is considered to be the crownless ruler of the market: Every
producer or manufacturer wants to know about the interest, fashion,
economic positionof the customers; where do they live, what is their
paying capacity, etc. Taking decisions on the basis of all these things,
the producers bring their products to the customers accordingly and
by means of their satisfaction, earn the maximum profits.
Decisions Regarding the Commodity. Before manufacturing the
product, various decisions have to be taken up, for instance, the size
of the product, its shade or colour, design and brand, packing, etc.
These all are equally the main components forming the marketing
process.
Decisions Regarding Price-Determination. Every producer or
manufacturer and the business organization has also to determine
beforehand, prior to undertaking its marketing, as to what shall be the
price of their product ? While deciding the price of the product, the
paying capacity of the customer and the cost of production has to be
borne in mind.
Decisions Regarding the Medium of Distribution. There are various
media of distribution.: the multiple or chain shops, the super bazar,
the wholesellers, the retailer, etc. The manufacturer or the business
concern has also to determine as to what shall remain the medium of

distribution of the commodity and how much long shall be its chain,
requiring how much of expenditure. While taking the decision of the
means of distribution, various matters have also to be borne into
mind.
Decisions Regarding Sales Promotion and Advertisements. In this age
of stiff competition, the sales promotion and advertisements have
become almost an inseparable part of the marketing. There are various
media of sales promotion and advertisements taking the decisions
about which is also an indispensable part of the sphere of marketing
management. In the sales promotion, various decisions are required to
be taken regarding the training of the sales representatives, their
emoluments and the relevant incentives, etc.
Decisions Regarding After-Sales Service. For the satisfaction of the
customers, the provision of after-sales service is very necessary.
Within the after-sales service, are included the free repairs, the return
or exchange of the product during the guarantee period if the product
proves defective or worthless, etc. In it is included the decision that
for how much period, what type of service has to be extended to the
customers, and through whom.
Nature of Marketing
With regard to the nature of marketing, it is observed as to whether
the marketing is a science or an art or both. On this topic, the
discussion can be held as follows:
Marketing as a 'Science’. It is essential for being called marketing
that there be some of the rules or principles of its own and in it the
scientific practices are followed. Marketing proves to be the most
effective in the form of a science since it has some of its own
principles and rules, and in it are used the scientific methods like
those of other social sciences. Today, before undertaking the
manufacturing of a product, the producer tries to collect various kinds
of researches and knowledge for instance, marketing research,
purchaser-behavior research, etc. All these facts prove the marketing
to be a science.
Marketing as an Art. Along with a special qualification and ability,
if some work is undertaken, it is known as 'art'. Within the marketing
itself, is covered the salesmanship. On the basis of salesmanship,

some of the shopkeepers extend their sales too much in comparison to
that of their other contemporary sellers. Marketing too is an art which
is acquired by studies and ability and by the proper training this art is
led to perfection. The various problems of marketing are solved by a
special art only.
After studying both the above, it might be said that marketing is both
an art and a science, since in it the scientific techniques and art are
used, and thereafter various decisions undertaken.
Various marketing concepts:
There are 5 different concepts of marketing, each of which vary in the
function that they deal with. For example – production concept deals
with production and selling concept deals with selling. Each of the
concepts was developed as per the need of the market. As the market
changed, so did the concepts of marketing. And today, we have an
opportunity to look at all 5 concepts of marketing and what they
represent.
Production Concept – Consumers prefer products that are widely
available and inexpensive. The production concept is more operations
oriented than any other concept.
Product Concept – Consumers favor products that offer the most
quality, performance, or innovative features. The product concept
believes in the consumer and it says the consumers are more likely to
be loyal if they have more options of products or they get more
benefits from the product of the company.
Selling Concept – Consumers will buy products only if the company
aggressively promotes or sells these products. Off course, in this era
of marketing, we know that selling is not the only tactic to sell your
product. You have to focus on marketing as well.
Marketing Concept – Focuses on needs/wants of target markets &
delivering value better than competitors. The marketing concept
believes in the pull strategy and says that you need to make your
brand so strong that customers themselves prefer your brand over
every other competitor. This can be achieved through marketing.
Societal Marketing Concept - This concept stresses not only the
customer satisfaction but also gives importance to Consumer
Welfare/Societal Welfare. This concept is almost a step further than

the marketing concept. Under this concept, it is believed that mere
satisfaction of the consumers would not help, and the welfare of the
whole society has to be kept in mind.
Marketing mix:
The Marketing mix is a set of four decisions which needs to be taken
before launching any new product. These variables are also known as
the 4 P’s of marketing. These four variables help the firm in making
strategic decisions necessary for the smooth running of any product /
organization.These variables are
Product
Price
Place
Promotions
Marketing mix is mainly of two types.
1) Product marketing mix – Comprised of Product, price, place and
promotions. This marketing mix is mainly used in case of Tangible
goods.
2) Service marketing mix – The service marketing mix has three
further variables included which are people, physical evidence and
process.
The term marketing mix was first coined by Neil H Borden back in
1964 in his article “The concept of marketing mix”. Several strategic
analysts over the years believe that the marketing mix can make or
break the firm. Having the right marketing mix at the start of the
marketing plan is absolutely essential. Over time the concept of
marketing mix has provided a steady platform for the launch of a new
product or business.
As mentioned before, the marketing mix is characterized by four
different but equally important variables. These variables are never
constant and may be changed over time. However, a change in one of
the variables may cause a change in all the other variables as well.
The variables are as follows
1) Product – The first thing you need, if you want to start a business,
is a product. Therefore, Product is also the first variable in the
marketing mix. Product decisions are the first decisions you need to
take before making any marketing plan. A product can be divided into

three parts. The core product, the augmented product and the tertiary
product. Before deciding on the product component there are some
questions which you need to ask yourself.
What product are you selling?
What would be the quality of your product?
Which features are different from the market?
What is the USP of the product?
Whether the product will be branded as sub brand or completely new?
What are the secondary products which can be sold along with
primary warranty andservices.
Based on these questions, several product decisions have to be made.
These product decisions will in turn affect the other variables of the
marketing mix. For example – You launch a car with is to have the
highest quality. Thus the pricing, promotions and placing would have
to be altered accordingly. Thus as long as you dont know your
product, you cannot decide any other variable of the marketing mix.
However, if the product features are not fitting in the marketing mix,
you can alter the product such that it finds a place for itself in the
marketing mix.
2) Pricing – Pricing of a product depends on a lot of different
variables and hence it is constantly updated. Major consideration in
pricing is the costing of the product, the advertising and marketing
expenses, any price fluctuations in the market, distribution costs etc.
Many of these factors can change separately. Thus the pricing has to
be such that it can bear the brunt of changes for a certain period of
time. However, if all these variables change, then the pricing of a
product has to be increased and decreased accordingly.
Along with the above factors, there are also other things which have
to be taken in consideration when deciding on a pricing strategy.
Competition can be the best example. Similarly, pricing also affects
the targeting and positioning of a product. Pricing is used for sales
promotions in the form of trade discounts. Thus based on these factors
there are several pricing strategies, one of which is implemented for
the marketing mix.
3) Place – Place refers to the distribution channel of a product. If a
product is a consumer product, it needs to be available as far and wide

as possible. On the other hand, if the product is a Premium consumer
product, it will be available only in select stores. Similarly, if the
product is a business product, you need a team who interacts with
businesses and makes the product available to them. Thus the place
where the product is distributed, depends on the product and pricing
decisions, as well as any STP decisions taken by a firm.
Distribution has a huge affect on the profitability of a product.
Consider a FMCG company which has national distribution for its
product. An increase in petrol rates by 10 rs will in fact bring about
drastic changes in the profitability of the company. Thus supply chain
and logistics decisions are considered as very important costing
decisions of the firm. The firm needs to have a full proof logistics and
supply chain plan for its distribution.
4) Promotions– Promotions in the marketing mix includes the
complete integrated marketing communications which in turn
includes ATL and BTL advertising as well as sales promotions.
Promotions are dependent a lot on the product and pricing decision.
What is the budget for marketing and advertising? What stage is the
product in? If the product is completely new in the market, it needs
brand / product awareness promotions, whereas if the product is
already existing then it will need brand recall promotions.
Promotions also decide the segmentation targeting and positioning of
the product. The right kind of promotions affect all the other three
variables – the product, price and place. If the promotions are
effective, you might have to increase distribution points, you might
get to increase the price because of the rising brand equity of the
product, and the profitability might support you in launching even
more products. However, the budget required for extensive
promotions is also high. Promotions is considered as marketing
expenses and the same needs to be taken in consideration while
deciding the costing of the product.

Marketing vs. selling:
According to Prof. Theodore Levitt ‘The difference between selling
and marketing is more than semantic. A truly marketing minded firm
tries to create value satisfying goods and services which the
consumers will want to buy. What is offers for sale is determined not
by the seller but by the buyers. The seller takes his cues from the
buyer and the product becomes the consequence of the marketing
effort, not vice versa. Selling merely concerns itself with the tricks
and techniques of getting the customers to exchange their cash for the
company’s products, it does not bother about the value satisfaction
that the exchange is all about. On the contrary, marketing views the
entire business as consisting of a tightly integrated effort to discover,
create, arouse ad satisfy customer needs.
SELLING
1 Emphasis is on the product
2 Company Manufactures the product first
3 Management is sales volume oriented
4 Planning is short-run-oriented in terms of today’s products and
markets
5 Stresses needs of seller
6 Views business as a good producing process
7 Emphasis on staying with existing technology and reducing costs
8 Different departments work as in a highly separate water tight
compartment
9 Cost determines Price
10 Selling views customer as a last link in business
MARKETING
1 Emphasis on consumer needs wants
2 Company first determines customers’ needs and wants and then
decides out how to deliver a product to satisfy these wants
3 Management is profit oriented
4 Planning is long-run-oriented in today’s products and terms of new
products, tomorrow’s markets and future growth
5 Stresses needs and wants of buyers
6 Views business as consumer producing process satisfying process
7 Emphasis on innovation on every existing technology and reducing
every sphere, on providing better costs value to the customer by
adopting a superior technology
8 All departments of the business integrated manner, the sole purpose
being generation of consumer satisfaction
9. Consumer determine price, price determines cost
10. Marketing views the customer last link in business as the very
purpose of the business
Customers values:
You make buying decisions every day. Should you buy the Skinny
Caramel Macchiato at Starbucks or the house blend coffee at the fast
food drive through? Is the new iPhone game app worth 99 cents, or
can you find a free game app that is basically the same thing?In every
buying decision, a consumer asks the same question: 'is what I am
going to receive worth what I have to give up in order to get it?' The
gain the consumer receives for the benefit is weighed against the cost
the consumer must pay to acquire the benefit. The value the
individual consumer places on a product or service becomes the
customer value for that offering.This customer value is weighed
against the customer values assigned for similar products and services
that would provide a similar benefit. Consumers will typically
purchase the item with the highest customer value among all offerings
in the marketplace. When you are deciding where to go for lunch, for
example, do you consider Subway to have a higher customer value
than Burger King?Every consumer has a unique set of needs and
resources, so no two consumers will place the same customer value
on the same product or service. The highest-quality product or service
does not always provide the highest customer value, since the benefit

of each item is measured against the cost. Some consumers are
willing to pay a high price for a quality product or a high level of
service, but others will make the decision that the same benefits are
not worth the price.On your next vacation, would you rather stay at
the Marriott or the Quality Inn? The Marriott will provide you with a
nicer room, a fancier lobby, and room service, but you might rather
spend the money you save by staying at the Quality Inn on souvenirs.
How Is Customer Value Delivered to the Customer?
There are three ways a company can establish customer value to its
customer base: Provide the consumer with the best cost.Companies
can choose to focus their efforts on providing a reliable product at a
reasonable price. The low price helps to increase the value of their
offering to the consumers even if it is weighted against a low benefit.
For example, you might place a high customer value in a meal at
McDonald's restaurant because you know you will receive a
consistent, satisfactory meal at a low price.
Provide the consumer with the best product.Companies that offer top-
quality products increase the customer value of their offerings to their
consumers by providing a high benefit, which exceeds the high cost.
Lexus, for example, makes a luxury car that many consumers
consider to be top quality. Lexus, along with other luxury car
manufacturers, is able to charge a premium price for their cars, since
they consistently produce cars of this high quality in the minds of
their consumers.
Provide the consumer with the best service.Companies that provide a
high level of service to their consumers increase their customer value
of their services by providing a high benefit, which exceeds the cost
for many consumers. Consumers who buy from these companies are
willing to pay more to be treated with exceptional service. The retailer
Nordstrom, for example, has legendary customer service that is
unmatched in the retail industry.
Marketing environment

The market environment is a marketing term and refers to factors and
forces that affect a firm’s ability to build and maintain successful
relationships with customers. Three levels of the environment are :
Micro (internal) environment - small forces within the company that
affect its ability to serve its customers. Micro environment – the
industry in which a company operates and the industry’s market(s).
Macro (national) environment - larger societal forces that affect the
microenvironment.
Micro-Environment
The company aspect of micro-environment refers to the internal
environment of the company. This includes all departments, such as
management, finance, research and development, purchasing,
operations and accounting. Each of these departments has an impact
on marketing decisions. For example, research and development have
input as to the features a product can perform and accounting
approves the financial side of marketing plans and budget in customer
dissatisfaction. Marketing managers must watch supply availability
and other trends dealing with suppliers to ensure that product will be
delivered to customers in the time frame required in order to maintain
a strong customer relationship.Marketing intermediaries refers to
resellers, physical distribution firms, marketing services agencies, and
financial intermediaries. These are the people that help the company
promote, sell, and distribute its products to final buyers. Resellers are
those that hold and sell the company’s product. They match the
distribution to the customers and include places such as Wal-Mart,

Target, and Best Buy. Physical distribution firms are places such as
warehouses that store and transport the company’s product from its
origin to its destination. Marketing services agencies are companies
that offer services such as conducting marketing research, advertising,
and consulting. Financial intermediaries are institutions such as
banks, credit companies and insurance companies.Another aspect of
micro-environment is the customer market. There are different types
of customer markets including consumer markets, business markets,
government markets, international markets, and reseller markets. The
consumer market is made up of individuals who buy goods and
services for their own personal use or use in their household. Business
markets include those that buy goods and services for use in
producing their own products to sell. This is different from the
reseller market which includes businesses that purchase goods to
resell as is for a profit. These are the same companies mentioned as
market intermediaries. The government market consists of
government agencies that buy goods to produce public services or
transfer goods to others who need them. International markets include
buyers in other countries and includes customers from the previous
categories. Competitors are also a factor in the micro-environment
and include companies with similar offerings for goods and services.
To remain competitive a company must consider who their biggest
competitors are while considering its own size and position in the
industry. The company should develop a strategic advantage over
their competitors.The final aspect of the microenvironment is publics,
which is any group that has an interest in or impact on the
organization’s ability to meet its goals. For example, financial publics
can hinder a company’s ability to obtain funds affecting the level of
credit a company has. Media publics include newspapers and
magazines that can publish articles of interest regarding the company
and editorials that may influence customers’ opinions. Government
publics can affect the company by passing legislation and laws that
put restrictions on the company’s actions. Citizen-action publics
include environmental groups and minority groups and can question
the actions of a company and put them in the public spotlight. Local
publics are neighborhood and community organizations and will also

question a company’s impact on the local area and the level of
responsibility of their actions. The general public can affect the
company as any change in their attitude, whether positive or negative,
can cause sales to go up or down because the general public is often
the company’s customer base. And finally those who are employed
within the company and deal with the organization and construction
of the company’s product.
Macro-Environment
The macro-environment refers to all forces that are part of the larger
society and affect the micro-environment. It includes concepts such as
demography, economy, natural forces, technology, politics, and
culture.Factors affecting organization in Macro environment are
known as PESTEL, that is: Political, Economical, Social,
Technological, Environmental and Legal.
Demography refers to studying human populations in terms of size,
density, location, age, gender, race, and occupation. This is a very
important factor to study for marketers and helps to divide the
population into market segments and target markets. An example of
demography is classifying groups of people according to the year they
were born. These classifications can be referred to as baby boomers,
who are born between 1946 and 1964, generation X, who are born
between 1965 and 1976, and generation Y, who are born between
1977 and 1994. Each classification has different characteristics and
causes they find important. This can be beneficial to a marketer as
they can decide who their product would benefit most and tailor their
marketing plan to attract that segment. Demography covers many
aspects that are important to marketers including family dynamics,
geographic shifts, work force changes, and levels of diversity in any
given area.
Another aspect of the macro-environment is the economic
environment. This refers to the purchasing power of potential
customers and the ways in which people spend their money. Within
this area are two different economies, subsistence and industrialized.
Subsistence economies are based more in agriculture and consume
their own industrial output. Industrial economies have markets that
are diverse and carry many different types of goods. Each is important

to the marketer because each has a highly different spending pattern
as well as different distribution of wealth.
The natural environment is another important factor of the macro-
environment. This includes the natural resources that a company uses
as inputs that affects their marketing activities. The concern in this
area is the increased pollution, shortages of raw materials and
increased governmental intervention. As raw materials become
increasingly scarcer, the ability to create a company’s product gets
much harder. Also, pollution can go as far as negatively affecting a
company’s reputation if they are known for damaging the
environment. The last concern, government intervention can make it
increasingly harder for a company to fulfill their goals as
requirements get more stringent.
The technological environment is perhaps one of the fastest changing
factors in the macro-environment. This includes all developments
from antibiotics and surgery to nuclear missiles and chemical
weapons to automobiles and credit cards. As these markets develop it
can create new markets and new uses for products. It also requires a
company to stay ahead of others and update their own technology as it
becomes outdated. They must stay informed of trends so they can be
part of the next big thing, rather than becoming outdated and suffering
the consequences financially.
The political environment includes all laws, government agencies,
and groups that influence or limit other organizations and individuals
within a society. It is important for marketers to be aware of these
restrictions as they can be complex. Some products are regulated by
both state and federal laws. There are even restrictions for some
products as to who the target market may be, for example, cigarettes
should not be marketed to younger children. There are also many
restrictions on subliminal messages and monopolies. As laws and
regulations change often, this is a very important aspect for a
marketer to monitor.
The final aspect of the macro-environment is the cultural
environment, which consists of institutions and basic values and
beliefs of a group of people. The values can also be further
categorized into core beliefs, which passed on from generation to

generation and very difficult to change, and secondary beliefs, which
tend to be easier to influence. As a marketer, it is important to know
the difference between the two and to focus your marketing campaign
to reflect the values of a target audience.
When dealing with the marketing environment it is important for a
company to become proactive. By doing so, they can create the kind
of environment that they will prosper in and can become more
efficient by marketing in areas with the greatest customer potential. It
is important to place equal emphasis on both the macro and micro
environment and to react accordingly to changes within them.
Corporate strategic planning:
Strategic planning is an organization's process of defining its
strategy, or direction, and making decisions on allocating its resources
to pursue this strategy. It may also extend to control mechanisms for
guiding the implementation of the strategy. Strategic planning became
prominent in corporations during the 1960s and remains an important
aspect of strategic management. It is executed by strategic planners or
strategists, who involve many parties and research sources in their
analysis of the organization and its relationship to the environment in
which it competes.
Strategy has many definitions, but generally involves setting goals,
determining actions to achieve the goals, and mobilizing resources to
execute the actions. A strategy describes how the ends (goals) will be
achieved by the means (resources). The senior leadership of an
organization is generally tasked with determining strategy. Strategy
can be planned (intended) or can be observed as a pattern of activity
(emergent) as the organization adapts to its environment or competes.
Strategy includes processes of formulation and implementation;
strategic planning helps coordinate both. However, strategic planning
is analytical in nature (i.e., it involves "finding the dots"); strategy
formation itself involves synthesis (i.e., "connecting the dots") via
strategic thinking. As such, strategic planning occurs around the
strategy formation activity.
Various marketing strategies:
1. Social Marketing:It refers to the design, implementation and
control of programs to increase the acceptability of a social cause or

practice among people e.g. No Smoking campaign in Delhi
University, publicity campaign for casting vote.
2. Augmented Marketing:It refers to providing additional services by
way of innovative offerings and benefits to the customers to increase
his level of satisfaction e.g. free home delivery service by
Supermarkets.
3.Direct Marketing:Marketing through various advertising media that
interact directly with consumers, generally calling for the consumer to
make a direct response, e.g. Catalogue Selling, Mail-order, Tele-
calling and TV shopping.
4. Relationship Marketing:Marketing through creating, maintaining
and enhancing strong long-term relationships with customers in order
to win his loyalty e.g. a restaurant can build relationships with
customers by sending him wishes and discount offers on his
birthdays.
5. Services Marketing:It is applying the concepts, tools and
techniques of marketing to services like banking, insurance, retailing,
educational etc.
6. Person Marketing:It consists of activities undertaken to create,
maintain or change attitudes or behavior towards particular people
like politicians, sports stars, film stars, professionals to promote their
careers and income.
7. Organisation Marketing:It consists of activities undertaken to
create, maintain or change attitudes and behavior of target audiences
towards an organisation.
8. Place Marketing:Place marketing involves activities undertaken to
create, maintain, or change attitudes and behavior towards particular
places e.g. tourism marketing.
9. Differential Marketing:A market-coverage strategy in which a firm
decides to target different markets through different strategies or
offers e.g. Hindustan Unilever offers different types and qualities
soaps for different markets and customers.
10. Synchro marketing:It refers to balancing the fluctuations in
irregular demand for a product due to seasons, timings etc, through
flexible pricing, promotion and other incentives e.g. heavy off-season
discount on woollens may increase its demand to some extent.

11. Concentrated Marketing:A market-coverage strategy in which a
firm focuses on only one or few markets.
12. De-marketing:Marketing strategies to reduce demand temporarily
or permanently, not to destroy demand but only to shift it e.g. Super
stores may offer no discounts on Saturdays, Sundays and holidays to
reduce overcrowd.
Marketing planning process:
The marketing planning process involves both the development of
objectives and specifications for how they will be accomplished.
There are five basic steps in the process in this process.
1. Determination of Organizational Objective: The basic objectives,
or goals, of the organization are the starting point for marketing
planning. They serve as the foundation from which marketing
objectives and plans are built. These objectives provide direction for
all phases of the organization and serve as standards in evaluating
performance. Soundly conceived goals should be S.M.A.R.T –
specific, measurable, attainable, realistic and time-specific.
2. Assessing Organizational Resources: Planning strategies are
influenced by a number of factors both within and outside the
organization. Organizational resources include capabilities in
production, marketing, finance, technology, and personnel. By
evaluating these resources, organizations can pinpoint their strengths
and weaknesses. Strengths help organizations set objectives, develop
plans for meeting objectives, and take advantage of marketing
opportunities. Resource weaknesses, on the other hand, may inhibit an
organization from taking advantage of marketing opportunities.
3. Evaluating Risks and Opportunities: Environmental factors –
competitive, political, legal, economic, technological and social – also
influence marketing opportunities. The emergence of new
technologies or innovations may open new opportunities for under-
marketed products. The marketing environment may also pose threats
to marketing opportunities. For example, a new genetically
engineered drug may be developed with the potential to become a $1
billion-a-year product. But a government agency may delay requests
to market the drug due to regulations.

4. Marketing Strategy: The net result of opportunity analysis is the
formulation of marketing objectives designed to achieve overall
organizational objectives and develop a marketing plan. The
marketing planning effort must be directed toward establishing
marketing strategies that are resource efficient, flexible, and
adaptable. The marketing strategy is the overall company program for
selecting a particular target market and then satisfying consumers in
that segment.
5. Implementing and Monitoring Marketing Plans: The overall
strategic marketing plan serves as the basis for a series of operating
plans necessary to move the organization toward accomplishment of
its objectives. At every step of the marketing planning process,
marketing managers use feedback to monitor and adapt strategies
when actual performance fails to match expectations.
Marketing information system:
A marketing information system (MIS) is a management information
system (MIS) designed to support marketing decision making. Jobber
(2007) defines it as a "system in which marketing data is formally
gathered, stored, analysed and distributed to managers in accordance
with their informational needs on a regular basis." In addition, the
online business dictionary defines Marketing Information System
(MIS) as "a system that analyses and assesses marketing information,
gathered continuously from sources inside and outside an
organization or a store." Furthermore, "an overall Marketing
Information System can be defined as a set structure of procedures
and methods for the regular, planned collection, analysis and
presentation of information for use in making marketing decisions.
Importance
Developing a MIS system is becoming extremely important as the
strength of economies rely on services and to better understand the
specific needs of customers. Kotler, et al. (2006) defined it more
broadly as "people, equipment, and procedures to gather, sort,
analyze, evaluate, and distribute needed, timely, and accurate
information to marketing decision makers.As our economy focuses on
services, marketing is becoming extremely important to "monitor the
marketing environment for changes in buyer behavior competition,

technology, economic conditions, and government policies. In this
sense, the role of marketing is becoming pivotal for an organization to
"adapt to changes in the market environment."Furthermore, as our
economy relies heavily on the acquisition of knowledge, MIS systems
are necessary to be able to define and differentiate the value
proposition that one organization provides with respect to another, as
well as to define their competitive advantage. (Harmon, 2003)The
main benefit of MIS systems is to integrate market-monitoring
systems with strategy development and the strategic implementation
of policies and processes that help capture and act on customer
management applications with marketing decision support systems.
This area constitutes Marketing intelligence that supports the analysis
and market-based activities that support customer relations and
customer service with real time information with real time
applications that support market based approaches.
Kotler's Model
According to Philip Kotler, the four components that comprise the
MIS system are Internal Reports (Records) System, Marketing
Research System, Marketing Intelligence System, and Marketing
Decision Support System.
1.Internal Reports System: It records various data from different
department of a company, which is regarded as a major source of
information.
2.Marketing Intelligence System: It is a main source used by
managers for gaining daily information of the external environment,
hence assists the managers to react to the changing rapidly.
3.Marketing Research System: It is used to collect primary and
secondary data, and displays the results in forms of reports.
4.Marketing Decision Support System: Compared to the supply of the
data by the three previous systems, it focuses more on processing the
data.
Main Structure of MIS
According to Robert Harmon (2003), MIS systems are composed on
four components: (1) user interfaces, (2) applications software, (3)
databases, and (4) systems support. The following is a description of
each one of these components.

1. User interfaces. The essential element of the MIS is the managers
who will use the system and the interface they need to effectively
analyze and use marketing information. The design of the system will
depend on what type of decision managers need to make.
2. Application software. These are the programs that marketing
decision makers use to collect, analyze, and manage data for the
purpose of developing the information necessary for marketing
decisions.
3. Database marketing. A marketing database is a system in which
marketing data files are organized and stored.
4. System support. This component consists of system managers who
manage and maintain the system assets including software and
hardware network, monitor its activities and ensure compliance with
organizational policies.
Along with these components, MIS systems include Marketing
Decision Support Systems (MDSS), which in turn rely on simple
systems such as Microsoft Excel, SPSS, and on-line analytical tools
that help collect data. Data compiled for analysis is stored and
processed from a data warehouse, which is simply a data repository
system that helps store and further process data collected internally
and externally. (Harmon, 2003)
Consumer behaviour:
Consumer behaviour is the study of individuals, groups, or
organizations and the processes they use to select, secure, use, and
dispose of products, services, experiences, or ideas to satisfy needs
and the impacts that these processes have on the consumer and
society. It blends elements from psychology, sociology, social
anthropology, marketing and economics. It attempts to understand the
decision-making processes of buyers, both individually and in groups
such as how emotions affect buying behaviour. It studies
characteristics of individual consumers such as demographics and
behavioural variables in an attempt to understand people's wants. It
also tries to assess influences on the consumer from groups such as
family, friends, sports, reference groups, and society in general.
Factors influencing consumer behaviour:

The consumer behaviour or buyer behaviour is influenced by several
factors or forces. They are: 1. Internal or Psychological factors 2.
Social factors 3. Cultural factors 4. Economic factors 5. Personal
factors!
i) Who is the market and what is the extent of their power with regard
to the organisation?
ii) What do they buy?
iii) Why do they buy?
iv) Who is involved in the buying?
v) How do they buy?
vi) When do they buy?
vii) Where do they buy?
The answers of these questions provide the understanding of the ways
in which buyers are most likely to respond to marketing stimuli. The
stimulus-response model of buyer behaviour is shown below.
The consumer behaviour or buyer behaviour is influenced by several

factors or forces. They are: 1. Internal or Psychological factors 2.
Social factors 3. Cultural factors 4. Economic factors 5. Personal
factors:

1. Internal or psychological factors:The buying behaviour of
consumers is influenced by a number of internal or psychological
factors. The most important ones Motivation and Perception.
a) Motivation:A need becomes a motive when it is aroused to a
sufficient level of intensity. A motive is a need that is sufficiently
pressing to drive the person to act. There can be of types of needs:
1. Biogenic needs:They arise from physiological states of tension
such as thirst, hunger
2. Psychogenic needs:They arise from psychological states of tension
such as needs for recognition, esteem
In the words of William J Stanton, “A motive can be defined as a
drive or an urge for which an individual seeks satisfaction. It becomes
a buying motive when the individual seeks satisfaction through the
purchase of something”. A motive is an inner urge (or need) that
moves a person to take purchase action to satisfy two kinds of wants
viz. core wants and secondary wants.
b) Perception:Human beings have considerably more than five senses.
Apart from the basic five (touch, taste, smell, sight, hearing) there are
senses of direction, the sense of balance, a clear knowledge of which
way is down, and so forth. Each sense is feeding information to the
brain constantly, and the amount of information being collected
would seriously overload the system if one took it all in. The brain
therefore selects from the environment around the individual and cuts
out the extraneous noise.In effect, the brain makes automatic
decisions as to what is relevant and what is not. Even though there
may be many things happening around you, you are unaware of most
of them; in fact, experiments have shown that some information is
filtered out by the optic nerve even before it gets to the brain. People
quickly learn to ignore extraneous noises: for example, as a visitor to
someone else’s home you may be sharply aware of a loudly ticking
clock, whereas your host may be entirely used to it, and unaware of it
except when making a conscious effort to check that the clock is still
running.
Therefore the information entering the brain does not provide a
complete view of the world around you. When the individual
constructs a world-view, she then assembles the remaining

information to map what is happening in the outside world. Any gaps
(and there will, of course, be plenty of these) will be filled in with
imagination and experience. The cognitive map is therefore not a
‘photograph’; it is a construct of the imagination. This mapping will
be affected by the following factors:
1. Subjectivity:This is the existing world-view within the individual
and is unique to that individual.
2. Categorisation:This is the ‘pigeonholing’ of information, and the
pre-judging of events and products. This can happen through a
process known as chunking, whereby the individual organises
information into chunks of related items. For example, a picture seen
while a particular piece of music is playing might be chunked as one
item in the memory, so that sight of the picture evokes the music and
vice versa.
3. Selectivity:This is the degree to which the brain is selecting from
the environment. It is a function of how much is going on around the
individual, and also of how selective (concentrated) the individual is
on the current task. Selectivity is also subjective: some people are a
great deal more selective than others.
4. Expectation:The lead individuals to interpret later information in a
specific way. For example, look at this series of numbers and letters:
5. Past experience:This leads us to interpret later experience in the
light of what we already know. Psychologists call this the law of
primacy, Sometimes sights, smells or sounds from our past will
trigger off inappropriate responses: the smell of bread baking may
recall a village bakery from twenty years ago, but in fact the smell
could have been artificially generated by an aerosol spray near the
supermarket bread counter.An example of cognitive mapping as
applied to perception of product quality might run as follows.The
consumer uses the input selector to select clues and assign values to
them. For quality, the cues are typically price, brand name and retailer
name. There are strong positive relationships between price and
quality in most consumers’ perceptions, and brand name and quality;
although the retailer name is less significant, it still carries some
weight.For example, many consumers would feel confident at Big
Bazaar would sell higher-quality items than the local corner shop, but

might be less able to distinguish between Food Bazaar and Giant
hyper store. The information is subjective in that the consumer will
base decisions on the selected information. Each of us selects
differently from the environment and each of us has differing views.
Informationabout quality will be pigeonholed, or categorised: the
individual may put Scoda Octavia in the same category as Mercedes
Benz or perhaps put Sony in the same slot as Aiwa.
2. Social factors:Man is a social animal. Hence, our behaviour
patterns, likes and dislikes are influenced by the people around us to a
great extent. We always seek confirmation from the people around us
and seldom do things that are not socially acceptable. The social
factors influencing consumer behaviour are a) Family, b) Reference
Groups, c) Roles and status.
a) Family:There are two types of families in the buyer’s life viz.
nuclear family and Joint family. Nuclear family is that where the
family size is small and individuals have higher liberty to take
decisions whereas in joint families, the family size is large and group
decision-making gets more preference than individual. Family
members can strongly influence the buyer behaviour, particularly in
the Indian contest. The tastes, likes, dislikes, life styles etc. of the
members are rooted in the family buying behaviour.
The family influence on the buying behaviour of a member may be
found in two ways
i) The family influence on the individual personality, characteristics,
attitudes and evaluation criteria and
ii) The influence on the decision-making process involved in the
purchase of goods and services. In India, the head of the family may
alone or jointly with his wife decides the purchase. So marketers
should study the role and the relative influence of the husband, wife
and children in the purchase of goods and services.
Influence of children on buying decisions:
First-born children generate more economic impact than higher-order
babies. First-born and only children have a higher achievement rate
than their siblings, and since the birth rate is falling, there are more of
them proportionally. More and more couples are choosing to have
only one child and families larger than two children are becoming a

rarity. Childlessness is also more common now than it was 30 years
ago.Children also have a role in applying pressure to their parents to
make particular purchasing decisions. The level of ‘pester power’
generated can be overwhelming, and parents will frequently give in to
the child’s demands. This is substantiated by the spurt of cartoon
channels like Cartoon Network, Pogo, Nick, Animax, Hungama or
Splash, all of which depend on the advertisements of all possible
products in which children have their influence over their parents.
Although the number of children is steadily declining, their
importance as consumers is not. Apart from the direct purchases of
things that children need, they influence decision making to a marked
extent. Children’s development as consumers goes through five
stages:
1. Observing
2. Making requests
3. Making selections
4. Making assisted purchases
5. Making independent purchases
Recent research has shown that pre-teens and young teens have a
greater influence on family shopping choices than do the parents
themselves, for these reasons:
i. Often they do the shopping anyway, because both parents are
working, and the children have the available time to go to the shops.
ii. They watch more TV, so are more influenced by advertising and
more knowledgeable about products.
iii. They tend to be more attuned to consumer issues and have the
time to shop around tor.
b) Reference group:
A group is two or more persons who share a set of norms and whose
relationship makes their behaviour interdependent. A reference group
is a group of people with whom an individual associate. It is a group
of people who strongly influence a person’s attitudes values and
behaviour directly or indirectly. Reference groups fall into many
possible groupings, which are not necessarily to be exhaustive (i.e.
non-over-lapping). The various reference groups are:

i) Membership or contractual groups:They are those groups to which
the person belongs and interacts. These groups have a direct influence
on their member’s behaviour.
ii) Primary or normative groups:They refer to groups of friends,
family members, neighbours co-workers etc whom we see most often.
In this case, there is fairly continuous or regular, but informal
interaction with cohesiveness and mutual participation, which result
in similar beliefs and behaviour within the group.
iii) Secondary groups:They include religious groups, professional
groups etc, which are composed of people whom we see occasionally.
These groups are less influential in shaping attitudes and controlling
behaviour but can exert influence on behaviour within the purview of
the subject of mutual interest. For example, you can be member of a
philately or literary club where you can discuss on mutually
interesting subjects.
iv) Aspiration group:These are group to which a person would like to
join as member. These groups can be very powerful in influencing
behaviour because the individual will often adopt the behaviour of the
aspirational group in the hopes of being accepted as a member.
Sometimes the aspirational groups are better off financially, or will be
more powerful; the desire join such groups is usually classed as
ambition.For example, a humble office worker may dream of one day
having the designation to be present in the company boardroom.
Advertising commonly uses images of aspirational groups, implying
that the use of a particular product will move the individual a little
closer to being a member of an aspirational group. Just consider
Nokia 6230 ad campaign where an young man with Nokia mobile is
shown to be capable to go the top position in the company, thus
instigating you to use the same model in order to join the same
aspirational group.
v) Dissociative or avoidance groups:These are groups whose value an
individual rejects and the individual does not want to be associated
with. For example, a senior corporate executive does not want to be
taken as a teenager. Hence, the individual will try to avoid certain
products or behaviours rather than be taken for somebody from the
dissociative group. In the just given example, the executive may not

use cigarette, perfume or car, which are very much teenager-oriented.
Like aspirational groups, the definition of a group as dissociative is
purely subjective and it varies from one individual to the next.
vi) Formal groups:These groups have a known list of members, very
often recorded somewhere. An example might be a professional
association, or a club. Usually the rules and structure of the group are
laid down in writing. There are rules for membership and members’
behaviour is constrained while they remain part of the group.
However, the constraints usually apply only to fairly limited areas of
behaviour; for example, the association of Chartered Accountants
(CA) or the Cost Accountants have laid down the codes of practice
for their members in their professional dealings, but has no interest in
what its members do as private citizens. Membership of such groups
may confer special privileges, such as job advancement or use of club
facilities, or may only lead to responsibilities in the furtherance of the
group’s aims.
vii) Informal groups:These are less structured, and are typically based
on friendship. An example would be an individual’s circle of friends,
which only exists for mutual moral support, company and sharing
experiences. Although there can be even greater pressure to conform
than would be the case to a formal group, there is nothing in
writing.Often informal groups expect a more rigorous standard of
behaviour across a wider range of activities that would a formal
group; such circles of friends are likely to develop rules of behaviour
and traditions that are more binding than written rules.
viii) Automatic groups:These are those groups, to which one belongs
by virtue of age, gender, culture or education. These are sometimes
also called category groups. Although at first sight it would appear
that these groups would not exert much influence on the members’
behaviour, because they are groups, which have not been joined
voluntarily, it seems that people are influenced by group pressure to
conform. For example, when buying clothes, older people are
reluctant to look like a teenager and hence they normally do not buy
jeans.
ix) Indirect groups:In this case, the customers are not in direct contact
with the influencers. For example, a film star like Shah Rukh Khan

pitches for Santro car, it obviously has a deep influence over the blind
fans.
x) Comparative groups:The members of this group are those with
whom you compare yourself. For example, you may compare yourself
with your brother or sister (sibling rivalry) or the colleagues and try to
emulate by possessing some unique products or brands like Modava
watch or Christian Dior perfume.
xi) Contactual group:The group with which we are in regular contacts
like college friends, office colleagues.
c) Roles and status:
A person participates in many groups like family, clubs, and
organisations. The person’s position in each group can be defined in
tern of role and status. A role consists of the activities that a person is
expected to perform. Each role carries a status. People choose
products that communicate their role and status in society. Marketers
must be aware of the status symbol potential of products and brands.
3. Cultural factors:
Kotler observed that human behaviour is largely the result of a
learning process and as such individuals grow up learning a set of
values, perceptions, preferences and behaviour patterns as the result
of socialisation both within the family and a series of other key
institutions. From this we develop a set of values, which determine
and drive behavioural patterns to a very large extent.According to
Schiffman and Kanuk, values include achievement, success,
efficiency, progress, material comfort, practicality, individualism,
freedom, humanitarianism, youthfulness and practicality. This broad
set of values is then influenced by the subcultures like nationality
groups, religious groups, racial groups and geographical areas, all of
which exhibit degrees of difference in ethnic taste, cultural
preferences, taboos, attitudes and lifestyle.
The influence of subcultures is subsequently affected by social
stratification or social class, which acts as a determinant of behaviour.
Social class is determined by a series of variables such as occupation,
income, education and values rather than by a single variable. People
within a particular social class are more similar than those from

different social classes, but they can move from one social class to
other in due time and circumstances.
Cultural factors consist of a) Culture, b) Sub culture and c) Social
class.
a) Culture:
Culture is the most fundamental determinant of a person’s want and
behaviour. The growing child acquires a set of values, perception
preferences and behaviours through his or her family and other key
institutions. Culture influences considerably the pattern of
consumption and the pattern of decision-making. Marketers have to
explore the cultural forces and have to frame marketing strategies for
each category of culture separately to push up the sales of their
products or services. But culture is not permanent and changes
gradually and such changes are progressively assimilated within
society.Culture is a set of beliefs and values that are shared by most
people within a group. The groupings considered under culture are
usually relatively large, but at least in theory a culture can be shared
by a few people. Culture is passed on from one group member to
another, and in particular is usually passed down from one generation
to the next; it is learned, and is therefore both subjective and
arbitrary.For example, food is strongly linked to culture. While fish is
regarded as a delicacy in Bengal, and the Bengalis boast of several
hundred different varieties, in Gujarat. Rajastan or Tamil Naru, fish is
regarded as mostly unacceptable food item. These differences in
tastes are explained by the culture rather than by some random
differences in taste between individuals; the behaviours are shared by
people from a particular cultural background.While cultural
generalities such as these are interesting and useful, it would be
dangerous to make assumptions about individuals from other
countries based on the kind of general findings in Hofstede’s work.
Individuals from within a culture differ more than do the cultures
from each other: in other words, the most individualistic Indian is a
great deal more individualistic than the most conformist American.
Having said that, such generalisations are useful when approaching
mass markets and are widely used when planning mass advertising
campaigns such as TV commercials.Culture can change over a period

of time, although such changes tend to be slow, since culture is deeply
built into people’s behaviour. From a marketing viewpoint, therefore,
it is probably much easier to work within a given culture than to try to
change it
b) Sub-Culture:Each culture consists of smaller sub-cultures that
provide more specific identification and socialisation for their
members. Sub-culture refers to a set of beliefs shared by a subgroup
of the main culture, which include nationalities, religions, racial
groups and geographic regions. Many sub-Cultures make up
important market segments and marketers have to design products and
marketing programs tailored to their needs.Although this subgroup
will share most of the beliefs of the main culture, they share among
themselves another set of beliefs, which may be at odds with those
held by the main group. For example, Indians are normally seen as
orthodox, conservative people, but rich, up-market youths do not
hesitate to enjoy night parties with liquor and women. Another
example is that, the urban educated or upper class exhibits more trace
of individualism although Indian culture is mostly collective in
nature.
c) Social class:Consumer behaviour is determined by the social class
to which they belong. The classification of socioeconomic groups is
known as Socio-Economic Classification (SEC). Social class is
relatively a permanent and ordered division in a society whose
members share similar value, interest and behaviour. Social class is
not determined by a single factor, such as income but it is measured
as a combination of various factors, such as income, occupation,
education, authority, power, property, ownership, life styles,
consumption, pattern etc.
There are three different social classes in our society. They are upper
class, middle class and lower class. These three social classes differ in
their buying behaviour. Upper class consumers want high-class goods
to maintain their status in the society. Middle class consumers
purchase carefully and collect information to compare different
producers in the same line and lower class consumers buy on impulse.

4. Economic Factors:Consumer behaviour is influenced largely by
economic factors. Economic factors that influence consumer
behaviour are
a) Personal Income
b) Family income,
c) Income expectations,
d) Savings,
e) Liquid assets of the Consumer,
f) Consumer credit,
g) Other economic factors.
a) Personal Income:
The personal income of a person is determinant of his buying
behaviour. The gross personal income of a person consists of
disposable income and discretionary income. The disposable personal
income refers to the actual income (i.e. money balance) remaining at
the disposal of a person after deducting taxes and compulsorily
deductible items from the gross income. An increase in the disposable
income leads to an increase in the expenditure on various items. A fall
in the disposable income, on the other hand, leads to a fall in the
expenditure on various items.
The discretionary personal income refers to the balance remaining
after meeting basic necessaries of life. This income is available for the
purchase of shopping goods, durable goods and luxuries. An increase
in the discretionary income leads to an increase in the expenditure on
shopping goods, luxuries etc. which improves the standard of living
of a person.
b) Family income:Family income refers to the aggregate income of all
the members of a family.Family income influences the buying
behaviour of the family. The surplus family income, remaining after
the expenditure on the basic needs of the family, is made available for
buying shopping goods, durables and luxuries.
c) Income Expectations:Income expectations are one of the important
determinants of the buying behaviour of an individual. If he expects
any increase in his income, he is tempted to spend more on shopping
goods, durable goods and luxuries. On the other hand, if he expects

any fall in his future income, he will curtail his expenditure on
comforts and luxuries and restrict his expenditure to bare necessities.
d) Savings:Savings also influence the buying behaviour of an
individual. A change in the amount of savings leads to a change in the
expenditure of an individual. If a person decides to save more out of
his present income, he will spend less on comforts and luxuries.
e) Liquid assets:Liquid assets refer to those assets, which can be
converted into cash quickly without any loss. Liquid assets include
cash in hand, bank balance, marketable securities etc If an individual
has more liquid assets, he goes in for buying comforts and luxuries.
On the other hand, if he has less liquid assets, he cannot spend more
on buying comforts and luxuries.
f) Consumer credit:Consumer credit refers to the credit facility
available to the consumers desirous of purchasing durable comforts
and luxuries. It is made available by the sellers, either directly or
indirect у through banks and other financial institutions. Hire
purchase, installment purchase, direct bank loans etc are the ways by
which credit is made available to the consumers.Consumer credit
influences consumer behaviour. If more consumer credit is available
on liberal terms, expenditure on comforts and luxuries increases, as it
induces consumers to purchase these goods, and raise their living
standard.
g) Other economic factor: Other economic factors like business
cycles, inflation, etc. also influence the consumer behaviour.
5. Personal factor:
Personal factors also influence buyer behaviour. The important
personal factors, which influence buyer behaviour, are a) Age, b)
Occupation, c) Income and d) Life Style
a) Age:Age of a person is one of the important personal factors
influencing buyer behaviour. People buy different products at their
different stages of cycle. Their taste, preference, etc also change with
change in life cycle.
b) Occupation:Occupation or profession of a person influences his
buying behaviour. The life styles and buying considerations and
decisions differ widely according to the nature of the occupation. For
instance, the buying of a doctor can be easily differentiated from that

of a lawyer, teacher, clerk businessman, landlord, etc. So, the
marketing managers have to design different marketing strategies suit
the buying motives of different occupational groups.
c) Income:Income level of people is another factor which can exert
influence in shaping the consumption pattern. Income is an important
source of purchasing power. So, buying pattern of people differs with
different levels of income.
d) Life Style:Life style to a person’s pattern or way of living as
expressed in his activity, interests and opinions that portrays the
“whole person” interacting with the environment. Marketing
managers have to design different marketing strategies to suit the life
styles of the consumers.
Business buying behaviour process:
Awareness: The process begins when a company identifies a need for
a purchase. It may want to replace an existing item, replenish stocks
or buy a new product that is just available on the market. You can also
stimulate a need that the company may not be aware of by advising
them of issues and challenges that other companies in their industry
face. The buying team next works with the requesting department to
firm up on the requirement. Your sales team can provide advice and
guidance at this stage by offering discussion papers or inviting
decision makers to workshops or seminars on the topic.
Specification:When the buying team has agreed requirements, it
prepares a detailed specification that sets out quantities, performance
and technical requirements for a product. Your sales team can support
this stage by advising the buying team on best practice or
collaborating with the buying team to develop the specification.
Buying teams then use the specification to search for potential
suppliers. They may search the Internet to find products or companies
that provide a match to their specification, so it is important that your
website features keywords that match your customers’ product or
service needs.
Proposals: When the buying team has identified potential suppliers, it
asks for detailed proposals from the suppliers. The team may issue a
formal document known as a request for proposal, or it may outline
requirements and invite potential suppliers to make a presentation or

submit a quotation. If the product or service has a precise
specification, the buying team may simply ask for price quotations. If
the product is more complex, it may ask for proposals on how a
supplier would meet the need.
Evaluation: The buying team evaluates suppliers’ proposals against
criteria such as price, performance and value for money. As well as
evaluating the product, they assess the supplier on factors such as
corporate reputation, financial stability, technical reputation and
reliability. You can influence decisions at this stage by providing
company information, case studies and independent reports that
review your company and products.
Order: Before the buying team places an order with the chosen
supplier, they negotiate price, discount, finance arrangements and
payment terms, as well as confirming delivery dates and any other
contractual matters. When the order is complete and delivered, the
buying team may add a further stage by reviewing the performance of
the product and the supplier. This stage may include imposition of
penalty charges if the product fails to meet the agreed specification.

Unit II
Market segmentation:
Market segmentation is a marketing strategy which involves dividing
a broad target market into subsets of consumers, businesses, or
countries that have, or are perceived to have, common needs,
interests, and priorities, and then designing and implementing
strategies to target them. Market segmentation strategies are generally
used to identify and further define the target customers and provide
supporting data for marketing plan elements such as positioning to
achieve certain marketing plan objectives. Businesses may develop
product differentiation strategies, or an undifferentiated approach,
involving specific products or product lines depending on the specific
demand and attributes of the target segment.
Types of market segmentation
The following are the most common forms of market segmentation
practices.
Geographic Segmentation: Marketers can segment according to
geographic criteria—nations, states, regions, countries, cities,
neighbourhoods, or postal codes. The geo-cluster approach combines
demographic data with geographic data to create a more accurate or
specific profile with respect to region, in rainy regions merchants can
sell things like raincoats, umbrellas and gumboots. In hot regions, one
can sell summer clothing. A small business commodity store may
target only customers from the local neighbourhood, while a larger
department store can target its marketing towards several
neighbourhoods in a larger city or area, while ignoring customers in
other continents. Geographic segmentation is important and may be
considered the first step to international marketing, followed by
demographic and psychographic segmentation.
Demographic Segmentation: Segmentation according to
demography is based on variables such as age, gender, occupation and
education level or according to perceived benefits which a product or
service may provide. Benefits may be perceived differently depending
on a consumer's stage in the life cycle. Demographic segmentation
divides markets into different life stage groups and allows for
messages to be tailored accordingly. A variant of this approach known

as firmographic or feature based segmentation is commonly used in
business-to-business markets (it’s estimated that 81% of B2B
marketers use this technique). Under this approach the target market
is segmented based on features such as company size (either in terms
of revenue or number of employees), industry sector or location
(country and/or region).
Behavioural Segmentation: Behavioural segmentation divides
consumers into groups according to their knowledge of, attitude
towards, usage rate, response, loyalty status, and readiness stage to a
product. There is an extra connectivity with all other market related
sources. Behavioural segmentation divides buyers into segments
based on their knowledge, attitudes, uses, or responses concerning a
product. Many marketers believe that behaviour variables are the best
starting point for building market segments.
Psychographic Segmentation: Psychographic segmentation, which
is sometimes called lifestyle, is measured by studying the activities,
interests, and opinions (AIOs) of customers. It considers how people
spend their leisure, and which external influences they are most
responsive to and influenced by. Psychographics are very important to
segmentation, because psychographics identify the personal activities
and targeted lifestyle the target subject endures, or the image they are
attempting to project. Mass media has a predominant influence and
effect on psychographic segmentation. Lifestyle products may pertain
to high involvement products and purchase decisions, to specialty or
luxury products and purchase decisions.
Occasional Segmentation: Occasion segmentation focuses on
analysing occasions, independent of the customers, such as
considering Coke for occasions of being thirsty, having dinner or
going out, without taking into consideration the differences an
affluent and middle-class customer would have during these
occasions.Occasional customer segmentation merges customer-level
and occasion-level segmentation models and provides an
understanding of the individual customers’ needs, behavior and value
under different occasions of usage and time. Unlike traditional
segmentation models, this approach assigns more than one segment to

each unique customer, depending on the current circumstances they
are under.
Segmentation by benefits: Segmentation can take place according to
benefits sought by the consumer or customer.
Cultural Segmentation: Cultural segmentation is used to classify
markets according to cultural origin. Culture is a strong dimension of
consumer behaviour and is used to enhance customer insight and as a
component of predictive models. Cultural segmentation enables
appropriate communications to be crafted to particular cultural
communities, which is important for message engagement in a wide
range of organisations, including businesses, government and
community groups. Cultural segmentation can be applied to existing
customer data to measure market penetration in key cultural segments
by product, brand, channel as well as traditional measures of recency,
frequency and monetary value. These benchmarks form an important
evidence-base to guide strategic direction and tactical campaign
activity, allowing engagement trends to be monitored over time.
Cultural segmentation can also be mapped according to state, region,
suburb and neighbourhood. This provides a geographical market view
of population proportions and may be of benefit in selecting
appropriately located premises, determining territory boundaries and
local marketing activities.
Targeting
After segmenting the market based on the different groups and
classes, you will need to choose your targets. Targeting means
selecting the market. Single strategy will not suit all consumer groups,
so it is important to develop specific strategies for your target
markets.
Three general strategies for selecting your target markets:
Undifferentiated Targeting: This approach views the market as one
group with no individual segments, therefore using a single marketing
strategy. This strategy may be useful for a business or product with
little competition where you may not need to tailor strategies for
different preferences.
Concentrated Targeting: This approach focuses on selecting a
particular market niche on which marketing efforts are targeted. Your

firm is focusing on a single segment, so you can concentrate on
understanding the needs and wants of that market intimately. Small
firms often benefit from this strategy as focusing on one segment
enables them to compete effectively against larger firms.
Multi-Segment Targeting: This approach is used if you need to
focus on two or more well defined market segments and want to
develop different strategies for them. Multi segment targeting offers
many benefits but can be costly as it involves greater input from
management, increased market research and increased promotional
strategies.
Prior to selecting a targeting strategy, you should perform a cost
benefit analysis between all available strategies and determine which
will suit your situation best.
Positioning: what you do with the mind of a customer.
Positioning is developing a product and brand image in the minds of
consumers. It can also include improving a customer's perception
about the experience they will have if they choose to purchase your
product or service. The business can positively influence the
perceptions of its chosen customer base through strategic promotional
activities and by carefully defining your business' marketing mix.
Effective positioning involves a good understanding of competing
products and the benefits that are sought by your target market. It also
requires you to identify a differential advantage with which it will
deliver the required benefits to the market effectively against the
competition. Business should aim to define themselves in the eyes of
their customers in regard to their competition.
Differentiation:
Differentiated marketing combines the best attributes of
undifferentiated marketing and concentrated marketing. It appeals to
two or more distinct market segments, with a different marketing plan
for each. Typically differentiated marketing creates more total sales
than undifferentiated marketing, but it also increases the costs of
doing business.
Some features of Differentiated Marketing are:
A. Differentiated Marketing also called as multisegment marketing is
wherein a company attempts to appeal to two or more clearly defined

market segments with a specific product and unique marketing
strategy tailored to each separate segment.
1. Firms such as Maruti-Suzuki use differentiated marketing to attract
all segments. Others, such as Hyundai, and Microsoft appeal to two or
more segments, but not all segments.
2. Some companies, such as Time Inc., use both undifferentiated
marketing and concentrated marketing approaches in their multiple-
segmentation strategy. They have one or more major brands for the
mass market and secondary brands geared toward specific segments.
B. Company resources and abilities must be able to produce and
market two or more different sizes, brands, or products. Costs vary,
depending on modifications needed.
C. Differentiated marketing should enable the firm to achieve several
objectives:
1. Sales maximization.
2. Recognition as a specialist.
3. Diversification.
D. Differentiated marketing can be achieved without involvement in
the majority fallacy.
E. Two or more sizable and distinct consumer groups are necessary.
The more clusters facing the firm, the greater the opportunity for
differentiated marketing.
F. Wholesalers and retailers usually find differentiated marketing to
be desirable, because it enables them to reach different consumers,
offers a degree of exclusivity, allows orders to be concentrated, and
encourages private labels.
G. Total profits should rise as the number of segments serviced
increases.
H. A firm must balance revenues obtained from selling to multiple
segments against the costs.
I. A company must be careful to maintain product distinctiveness in
each consumer segment and to guard its image.
Competitors analysis:
Competitor analysis in marketing and strategic management is an
assessment of the strengths and weaknesses of current and potential
competitors. This analysis provides both an offensive and defensive

strategic context to identify opportunities and threats.Competitor
analysis is an essential component of corporate strategy.
One common and useful technique is constructing a competitor array.
The steps include:
Define your industry - scope and nature of the industry
Determine who your competitors are
Determine who your customers are and what benefits they expect
Determine what the key success factors are in your industry
Rank the key success factors by giving each one a weighting - The
sum of all the weightings must add up to one.
Rate each competitor on each of the key success factors
Multiply each cell in the matrix by the factor weighting.
Competitor profiling
The strategic rationale of competitor profiling is powerfully simple.
Superior knowledge of rivals offers a legitimate source of competitive
advantage. The raw material of competitive advantage consists of
offering superior customer value in the firm’s chosen market. The
definitive characteristic of customer value is the adjective, superior.
Customer value is defined relative to rival offerings making
competitor knowledge an intrinsic component of corporate strategy.
Profiling facilitates this strategic objective in three important ways.[5]
First, profiling can reveal strategic weaknesses in rivals that the firm
may exploit. Second, the proactive stance of competitor profiling will
allow the firm to anticipate the strategic response of their rivals to the
firm’s planned strategies, the strategies of other competing firms, and
changes in the environment. Third, this proactive knowledge will give
the firms strategic agility. Offensive strategy can be implemented
more quickly in order to exploit opportunities and capitalize on
strengths. Similarly, defensive strategy can be employed more deftly
in order to counter the threat of rival firms from exploiting the firm’s
own weaknesses.Clearly, those firms practicing systematic and
advanced competitor profiling have a significant advantage. As such,
a comprehensive profiling capability is rapidly becoming a core
competence required for successful competition. An appropriate
analogy is to consider this advantage as akin to having a good idea of
the next move that your opponent in a chess match will make. By

staying one move ahead, checkmate is one step closer. Indeed, as in
chess, a good offense is the best defense in the game of business as
well.A common technique is to create detailed profiles on each of
your major competitors. These profiles give an in-depth description of
the competitor's background, finances, products, markets, facilities,
personnel, and strategies. This involves:
Background
location of offices, plants, and online presences
history - key personalities, dates, events, and trends
ownership, corporate governance, and organizational structure
Financials
P-E ratios, dividend policy, and profitability
various financial ratios, liquidity, and cash flow
profit growth profile; method of growth (organic or acquisitive)
Products
products offered, depth and breadth of product line, and product
portfolio balance
new products developed, new product success rate, and R&D
strengths
brands, strength of brand portfolio, brand loyalty and brand awareness
patents and licenses
quality control conformance
reverse engineering or deformulation
Marketing
segments served, market shares, customer base, growth rate, and
customer loyalty
promotional mix, promotional budgets, advertising themes, ad agency
used, sales force success rate, online promotional strategy
distribution channels used (direct & indirect), exclusivity agreements,
alliances, and geographical coverage
pricing, discounts, and allowances
Facilities
plant capacity, capacity utilization rate, age of plant, plant efficiency,
capital investment
location, shipping logistics, and product mix by plant
Personnel

number of employees, key employees, and skill sets
strength of management, and management style
compensation, benefits, and employee morale & retention rates
Corporate and marketing strategies
objectives, mission statement, growth plans, acquisitions, and
divestitures
marketing strategies
Product is anything that can be offered to a market that might satisfy
a want or need.Product is a bundle of benefits-physical and
psychological- that marketer wants to offer, or a bundle of
expectations that consumers want to fulfil. Marketer can satisfy needs
and wants of target consumers by products. Product includes both
good and service. Normally, product is taken as a tangible object,
such as a pen, television set, bread, book, vehicle, table, etc. But,
tangible product is a package of services or benefits. Marketer should
consider product benefits and services, instead of product itself.
Importance lies in the services rendered by the product, and not
tangible object itself. People are not interested just possessing
products, but the services rendered by the products. For examples, we
do not buy a pen, but writing service. Similarly, we do not buy a car,
but transportation service. Just owning product is not enough. It must
serve our need and want. Thus, physical product is just a vehicle or
medium that offer services, benefits, and satisfaction to us.Product
can also be referred as a bundle of satisfaction, physical and
psychological both. Product includes:
 Core Product: Core product includes basic contents, benefits,
qualities, or utilities.
 Product-related Features: They include colour, branding,
packing, labeling, and varieties.
 Product-related Services: They include after-sales services,
installation, guarantee and warrantee, free home delivery, free
repairing, and so forth. As per the definition, anything which can
satisfy need and want of consumers is a product. Thus, product may
be in form of physical object, person, idea, activity, or organisation
that can provide any kind of services that satisfy some customer needs
or wants.
Characteristics of Product:
Careful analysis of concept of product essentially reveals following
features:
 Product is one of the elements of marketing mix or programme.
 Different people perceive it differently. Management, society,
and consumers have different expectations.
 Product includes both good and service.
 Marketer can actualize its goals by producing, selling,
improving, and modifying the product.
 Product is a base for entire marketing programme.
 In marketing terminology, product means a complete product
that can be sold to consumers. That means branding, labeling, colour,
services, etc., constitute the product.
 Product includes total offers, including main qualities, features,
and services.
 It includes tangible and non-tangible features or benefits.
 It is a vehicle or medium to offer benefits and satisfaction to
consumers.
 Important lies in services rendered by the product, and not
ownership of product. People buy services, and not the physical
object.
Types of Product:
A company sells different products (goods and services) to its target
market.
They can be classified into two groups, such as: Consumer Product,
and Industrial Products
Consumer Products: Consumer products are those items which are
used by ultimate consumers or households and they can be used
without further commercial and engineering processes.
Consumer products can be divided into four types as under:
1. Convenient Products: Such products improve or enhance users’
convenience. They are used in a day-to-day life. They are frequently
required and can be easily purchased. For example, soaps, biscuits,
toothpaste, razors and shaving creams, newspapers, etc. They are
purchased spontaneously, without much consideration, from nearby
shops or retail malls.
2. Shopping Products: These products require special time and
shopping efforts. They are purchased purposefully from special shops
or markets. Quality, price, brand, fashion, style, getup, colour, etc.,
are important criteria to be considered. They are to be chosen among
various alternatives or varieties. Gold and jewelleries, footwear,
clothes, and other durables (including refrigerator, television, wrist
washes, etc.).
3. Durable Products: Durable products can last for a longer period
and can be repeatedly used by one or more persons. Television,
computer, refrigerator, fans, electric irons, vehicles, etc., are examples
of durable products. Brand, company image, price, qualities
(including safety, ease, economy, convenience, durability, etc.),
features (including size, colour, shape, weight, etc.), and after-sales
services (including free installation, home delivery, repairing,
guarantee and warrantee, etc.) are important aspects the customers
consider while buying these products.
4. Non-durable Products: As against durable products, the non-
durable products have short life. They must be consumed within short
time after they are manufactured. Fruits, vegetables, flowers, cheese,
milk, and other provisions are non-durable in nature. They are used
for once. They are also known as consumables. Mostly, many of them
are non-branded. They are frequently purchased products and can be
easily bought from nearby outlets. Freshness, packing, purity, and
price are important criteria to purchase these products.
5. Services: Services are different than tangible objects.
Intangibility, variability, inseparability, perishability, etc., are main
features of services. Services make our life safe and comfortable.
Trust, reliability, costs, regularity, and timing are important issues.
The police, the post office, the hospital, the banks and insurance
companies, the cinema, the utility services by local body, the
transportation facilities, and other helpers (like barber, cobbler,
doctor, mechanic, etc.,) can be included in services. All marketing
fundamental are equally applicable to services. ‘Marketing of
services’ is the emerging facet of modern marketing.
Industrial Products: Industrial products are used as the inputs by
manufacturing firms for further processes on the products or

manufacturing other products. Some products are both industrial as
well as consumer products. Machinery, components, certain
chemicals, supplies and services, etc., are some industrial products.
Again, strict classification in term of industrial consumer and
consumer products is also not possible, for example, electricity,
petroleum products, sugar, cloth, wheat, computer, vehicles, etc., are
used by industry as the inputs while the same products are used by
consumers for their daily use as well. Some companies, for example,
electricity, cements, petrol and coals, etc., sell their products to
industrial units as well as to consumers. As against consumer
products, the marketing of industrial products differs in many ways.
Industrial products include:
 Machines and components
 Raw-materials and supplies
 Services and consultancies
 Electricity and Fuels, etc.
Product Life Cycle: As consumers, we buy millions of products
every year. And just like us, these products have a life cycle. Older,
long-established products eventually become less popular, while in
contrast, the demand for new, more modern goods usually increases
quite rapidly after they are launched. Because most companies
understand the different product life cycle stages, and that the
products they sell all have a limited lifespan, the majority of them will
invest heavily in new product development in order to make sure that
their businesses continue to grow.
Product Life Cycle Stages
The product life cycle has 4 very clearly defined stages, each with its
own characteristics that mean different things for business that are
trying to manage the life cycle of their particular products.
Introduction Stage – This stage of the cycle could be the most
expensive for a company launching a new product. The size of the
market for the product is small, which means sales are low, although
they will be increasing. On the other hand, the cost of things like
research and development, consumer testing, and the marketing
needed to launch the product can be very high, especially if it’s a
competitive sector.
Growth Stage – The growth stage is typically characterized by a
strong growth in sales and profits, and because the company can start
to benefit from economies of scale in production, the profit margins,
as well as the overall amount of profit, will increase. This makes it
possible for businesses to invest more money in the promotional
activity to maximize the potential of this growth stage.
Maturity Stage – During the maturity stage, the product is
established and the aim for the manufacturer is now to maintain the
market share they have built up. This is probably the most
competitive time for most products and businesses need to invest
wisely in any marketing they undertake. They also need to consider
any product modifications or improvements to the production process
which might give them a competitive advantage.
Decline Stage – Eventually, the market for a product will start to
shrink, and this is what’s known as the decline stage. This shrinkage
could be due to the market becoming saturated (i.e. all the customers
who will buy the product have already purchased it), or because the
consumers are switching to a different type of product. While this
decline may be inevitable, it may still be possible for companies to
make some profit by switching to less-expensive production methods
and cheaper markets.
Product Mix: Product mix or product assortment is a set of the total

number of products lines that a seller offers in the market to its
buyers.
Product Mix4 Dimensions of the Product Mix – 4 Product Mix
Decisions

Four important dimensions of a product mix can be identified. These
are: width, length, depth, and consistency. The first of the product mix
decisions refers to the product mix width. The width is all about the
number of different product lines the company carries. As mentioned
in the previous example, Colgate has 3 product lines. Thus, it has a
rather limited width.
The product mix length refers to the total number of items a company
carries within the product lines. For instance, Colgate carries several
different brands within each line. In Colgate’s oral care product line,
several different categories of toothpastes can be identified. A car
manufacturer may have several series in its car product line, such as
3-series, 5-series, and 7-series.
The next one of the product mix decisions is the product mix depth. It
refers to the number of versions offered for each product in the
product line. For instance, Colgate toothpastes come in several tastes
and variations. The vehicle manufacturer’s 3-series in the car product
line may be offered in several versions: convertible, coupé, sedan, and
so further.
Finally, the consistency of a product mix completes our four product
mix decisions. Consistency refers to how closely related the product
lines are in terms of end use, production requirements, distribution
channels or any other way. In Colgate’s case, we can observe a rather
strong consistency, which is based on the fact that all product lines
constitute consumer products and go through the same distribution
channels. The vehicle manufacturer also has a relatively consistent
product mix, since both product lines contain consumer-vehicles, can
be sold in the same way etc.New product development:
In business and engineering, new product development (NPD) is the
complete process of bringing a new product to market. New product
development is described in the literature as the transformation of a
market opportunity into a product available for sale and it can be
tangible (that is, something physical you can touch) or intangible (like
a service, experience, or belief). A good understanding of customer
needs and wants, the competitive environment and the nature of the
market represent the top required factors for the success of a new
product. Cost, time and quality are the main variables that drive the

customer needs. Aimed at these three variables, companies develop
continuous practices and strategies to better satisfy the customer
requirements and increase their market share by a regular
development of new products. There are many uncertainties and
challenges throughout the process which companies must face. The
use of best practices and the elimination of barriers to communication
are the main concerns for the management of NPD process.
Packaging and labeling: Packaging is the technology of enclosing
or protecting products for distribution, storage, sale, and use.
Packaging also refers to the process of design, evaluation, and
production of packages. Packaging can be described as a coordinated
system of preparing goods for transport, warehousing, logistics, sale,
and end use. Packaging contains, protects, preserves, transports,
informs, and sells. In many countries it is fully integrated into
government, business, institutional, industrial, and personal use.
The purposes of packaging and package labels
Physical protection – The objects enclosed in the package may require
protection from, among other things, mechanical shock, vibration,
electrostatic discharge, compression, temperature, etc.
Barrier protection – A barrier from oxygen, water vapor, dust, etc., is
often required. Permeation is a critical factor in design. Some
packages contain desiccants or oxygen absorbers to help extend shelf
life. Modified atmospheres or controlled atmospheres are also
maintained in some food packages. Keeping the contents clean, fresh,
sterile and safe for the intended shelf life is a primary function. A
barrier is also implemented in cases where segregation of two
materials, prior to end use is required, as in case of special paints,
glues, medical fluids etc. At consumer end, the packaging barrier is
broken or measured amounts of material removed for mixing and
subsequent end use.
Containment or agglomeration – Small objects are typically grouped
together in one package for reasons of efficiency. For example, a
single box of 1000 pencils requires less physical handling than 1000
single pencils. Liquids, powders, and granular materials need
containment.

Information transmission – Packages and labels communicate how to
use, transport, recycle, or dispose of the package or product. With
pharmaceuticals, food, medical, and chemical products, some types of
information are required by governments. Some packages and labels
also are used for track and trace purposes. Most items include their
serial and lot numbers on the packaging, and in the case of food
products, medicine, and some chemicals the packaging often contains
an expiry/best-before date, usually in a shorthand form. Packages may
indicate their material with a symbol.
Marketing – The packaging and labels can be used by marketers to
encourage potential buyers to purchase the product. Package graphic
design and physical design have been important and constantly
evolving phenomenon for several decades. Marketing
communications and graphic design are applied to the surface of the
package and (in many cases) the point of sale display. Most
packaging is designed to reflect the brand's message and identity.
Security – Packaging can play an important role in reducing the
security risks of shipment. Packages can be made with improved
tamper resistance to deter tampering and also can have tamper-evident
features to help indicate tampering. Packages can be engineered to
help reduce the risks of package pilferage or the theft and resale of
products: Some package constructions are more resistant to pilferage
and some have pilfer indicating seals. Counterfeit consumer goods,
unauthorized sales (diversion), material substitution and tampering
can all be prevented with these anti-counterfeiting technologies.
Packages may include authentication seals and use security printing to
help indicate that the package and contents are not counterfeit.
Packages also can include anti-theft devices, such as dye-packs, RFID
tags, or electronic article surveillance tags that can be activated or
detected by devices at exit points and require specialized tools to
deactivate. Using packaging in this way is a means of loss prevention.
Convenience – Packages can have features that add convenience in
distribution, handling, stacking, display, sale, opening, reclosing, use,
dispensing, reuse, recycling, and ease of disposal
Portion control – Single serving or single dosage packaging has a
precise amount of contents to control usage. Bulk commodities (such

as salt) can be divided into packages that are a more suitable size for
individual households. It also aids the control of inventory: selling
sealed one-liter-bottles of milk, rather than having people bring their
own bottles to fill themselves.
Packaging types
Various household packaging types for foods
Packaging may be looked at as being of several different types. For
example, a transport package or distribution package can be the
shipping container used to ship, store, and handle the product or inner
packages. Some identify a consumer package as one which is directed
toward a consumer or household.Packaging may be described in
relation to the type of product being packaged. It is sometimes
convenient to categorize packages by layer or function: "primary",
"secondary", etc.
Primary packaging is the material that first envelops the product and
holds it. This usually is the smallest unit of distribution or use and is
the package which is in direct contact with the contents.
Secondary packaging is outside the primary packaging, perhaps used
to group primary packages together.
Tertiary packaging is used for bulk handling, warehouse storage and
transport shipping. The most common form is a palletized unit load
that packs tightly into containers.
These broad categories can be somewhat arbitrary. For example,
depending on the use, a shrink wrap can be primary packaging when
applied directly to the product, secondary packaging when combining
smaller packages, and tertiary packaging on some distribution packs.
Symbols used on packages and labels
Many types of symbols for package labeling are nationally and
internationally standardized. For consumer packaging, symbols exist
for product certifications (such as the FCC and TÜV marks),
trademarks, proof of purchase, etc. Some requirements and symbols
exist to communicate aspects of consumer rights and safety, for
example the CE marking or the estimated sign that notes conformance
to EU weights and measures accuracy regulations. Examples of
environmental and recycling symbols include the recycling symbol,
the recycling code (which could be a resin identification code), and

the "Green Dot". Food packaging may show food contact material
symbols. In the European Union, products of animal origin which are
intended to be consumed by humans have to carry standard, oval-
shaped EC identification and health marks for food safety and quality
insurance reasons.
Bar codes, Universal Product Codes, and RFID labels are common to
allow automated information management in logistics and retailing.
Country of Origin Labeling is often used. Some products might use
QR codes or similar matrix barcodes. Packaging may have visible
registration marks and other printing calibration/troubleshooting cues.
Product and brand relationship
A Brand is a recognized name in a market, through which client can
associate with, in today's world brand has actually ended up being
rather essential, need for top quality product has actually increased
dramatically. The factor behind this pattern is that individuals
presume that top quality items transcend in quality and provide more
fulfilment compared with non top quality product, with increasing per
capita earnings a growing economies there is a considerable boost in
need for top quality items. And here comes the relationship in
between the brand and a product, when a client purchases a product of
particular brand, he has expectations that have actually been set by the
online marketer while marketing the product, and it's needed that
these expectations are satisfied by the product.If the quality of product
being provided by that brand is constant throughout the time, brand
image stays in the hearts of individuals just. Whenever a particular
brand presents some brand-new product, individuals have
expectations from their previous experience with the brand and they
anticipate the very same or often much more, it's crucial for a product
to please their expectations. There is a direct relationship in between a
product and its brand since a product is exactly what represents the
brand, so if the product stops working the brand experiences an
obstacle as well as one stopped working product can show to be
deadly since of the stiff competitors in the market.
Brand attributes and Strategies:

Brand attributes are the functional and emotional associations which
are assigned to a brand by its customers and prospects. They are the
basic elements for establishing a brand identity.
A strong brand must have following attributes:
 Relevancy- A strong brand must be relevant. It must meet
people’s expectations and should perform the way they want it to. A
good job must be done to persuade consumers to buy the product; else
inspite of your product being unique, people will not buy it.
 Consistency- A consistent brand signifies what the brand stands
for and builds customers trust in brand. A consistent brand is where
the company communicates message in a way that does not deviate
from the core brand proposition.
 Proper positioning- A strong brand should be positioned so that
it makes a place in target audience mind and they prefer it over other
brands.
 Sustainable- A strong brand makes a business competitive. A
sustainable brand drives an organization towards innovation and
success. Example of sustainable brand is Marks and Spencer’s.
 Credibility- A strong brand should do what it promises. The way
you communicate your brand to the audience/ customers should be
realistic. It should not fail to deliver what it promises. Do not
exaggerate as customers want to believe in the promises you make to
them.
 Inspirational- A strong brand should transcend/ inspire the
category it is famous for. For example- Nike transcendent Jersey Polo
Shirt.
 Uniqueness- A strong brand should be different and unique. It
should set you apart from other competitors in market.
 Appealing- A strong brand should be attractive. Customers
should be attracted by the promise you make and by the value you
deliver.
Branding consists of a set of complex branding decisions. Major
brand strategy decisions involve brand positioning, brand name
selection, brand sponsorship and brand developmentCo-branding, two
companies/brands partner with each other to develop a product or an

initiative, and sign such product or initiative with both brand names as
the source.
Brand equity:The American Marketing Association defines brand
equity this way: from a consumer perspective, brand equity is based
on consumer attitudes about positive brand attributes and favorable
consequences of brand use.Brand equity in the positive form can help
a company in many ways. A common benefit that typically results is
the financial benefit, which allows for a company to demand a
premium price for its product. For example, costa coffee has such
strong brand equity that the premium price is both accepted and
expected by customers. In addition, brand equity provides the ability
for companies to expand product lines, which can increase sales and
revenues for the business and in some cases reduce costs. An example
of this benefit can be seen in companies such as Oakley. Their
sunglasses have such positive brand equity that they require little to
no awareness, promotion or discount sales. The outcome from this is
that marketing budgets have more strategic flexibility and require less
investment. A company with positive brand equity finds itself better
positioned for success because customers have special connections
and loyalties to its brand. This enables companies to manoeuvre
through dynamic market challenges better than companies with less
equity in their brands.
Components of Brand Equity: Increased market share is one result
of customer brand loyalty and brand equity. There are four
components that provide these results:
Brand Recognition - The brand is widely known and recognized, and
consumers know what it provides in relationship to the competition.
Brand Experience - Consumers have used and experienced the
product enough to build expectation.
Brand Preference - The brand is preferred by consumers, and as a
result, they become returning customers.
Brand Loyalty - The brand and the consumer have an emotional
attachment, and the consumer will go to any length to purchase it.
As consumer loyalty grows there comes a point when no alternative
or substitute will satisfy the customer's needs. The brand remains
present on the customer's mind and customer/brand connection is

formed. At this point, it is critical for the company to continue
building loyalty with customers and sustain commitment with
consumers.
New product development process:
 Idea Generation: Ideas for new products can be obtained from
basic research using a SWOT analysis (Strengths, Weaknesses,
Opportunities & Threats). Market and consumer trends, company's
R&D department, competitors, focus groups, employees, salespeople,
corporate spies, trade shows, or ethnographic discovery methods
(searching for user patterns and habits) may also be used to get an
insight into new product lines or product features. Lots of ideas are
generated about the new product. Out of these ideas many are
implemented. The ideas are generated in many forms. Many reasons
are responsible for generation of an idea. Idea for new product can
come from many sources, such as customer, scientists, competitors,
employees, channel member, and top management. customer need
and wants are the logical place to start the search.
 Idea Screening: The object is to eliminate unsound concepts
prior to devoting resources to them.
 Idea Development and Testing: Develop the marketing and
engineering details. Product idea is an idea for a possible product that
the company can see itself offering to the market. Testing the Idea
may involve asking a number of prospective customers to evaluate the
idea
 Business Analysis : Estimate likely selling price based upon
competition and customer feedback. Estimate sales volume based
upon size of market and estimation of profitability and break-even
point etc.
 Beta Testing and Market Testing : Produce a physical prototype
or mock-up.Test the product (and its packaging) in typical usage
situations .Conduct focus group customer interviews or introduce at
trade show. Make adjustments where necessary. Produce an initial run
of the product and sell it in a test market area to determine customer
acceptance

 Technical Implementation: Publish technical communications
such as data sheets. Engineering operations planning. Department
scheduling. Program review and monitoring
 Commercialization: Launch the product. Fill the distribution
pipeline with product.
 New Product Pricing :. Fix the product cost based on segments,
competition and considering the fixed and variable factors.
Services:Services are (usually) intangible economic activities offered
by one party to another. Often time-based, services performed bring
about desired results to recipients, objects, or other assets for which
purchasers have responsibility. In exchange for money, time, and
effort, service customers expect value from access to goods, labour,
professional skills, facilities, networks, and systems; but they do not
normally take ownership of any of the physical elements involved.
There has been a long academic debate on what makes services
different from goods. The historical perspective in the late-eighteen
and early-nineteenth centuries focused on creation and possession of
wealth. Classical economists contended that goods were objects of
value over which ownership rights could be established and
exchanged. Ownership implied tangible possession of an object that
had been acquired through purchase, barter or gift from the producer
or previous owner and was legally identifiable as the property of the
current owner. More recently, scholars have found that services are
different than goods and that there are distinct models to understand
the marketing of services to customers.
Service Marketing Mix – 7 P’s of marketing
The service marketing mix is also known as an extended marketing
mix and is an integral part of a service blueprint design. The service
marketing mix consists of 7 P’s as compared to the 4 P’s of a product
marketing mix. Simply said, the service marketing mix assumes the
service as a product itself. However, it adds 3 more P’s which are
required for optimum service delivery.
Service Marketing Mix
The product marketing mix consists of the 4 P’s which are Product,
Pricing, Promotions and Placement. These are discussed in my article
on product marketing mix – the 4 P’s.
The extended service marketing mix places 3 further P’s which
include People, Process and Physical evidence. All of these factors
are necessary for optimum service delivery. Let us discuss the same in
further detail.
Product – The product in service marketing mix is intangible in
nature. Like physical products such as a soap or a detergent, service
products cannot be measured. Tourism industry or the education
industry can be an excellent example. At the same time service
products are heterogenous, perishable and cannot be owned. The
service product thus has to be designed with care. Generally, service
blue printing is done to define the service product. For example – a
restaurant blue print will be prepared before establishing a restaurant
business. This service blue print defines exactly how the product (in
this case the restaurant) is going to be.
Place – Place in case of services determine where is the service
product going to be located. The best place to open up a petrol pump
is on the highway or in the city. A place where there is minimum
traffic is a wrong location to start a petrol pump. Similarly, a software
company will be better placed in a business hub with a lot of
companies nearby rather than being placed in a town or rural area.
Promotion – Promotions have become a critical factor in the service
marketing mix. Services are easy to be duplicated and hence it is
generally the brand which sets a service apart from its counterpart.
You will find a lot of banks and telecom companies promoting
themselves rigorously. Why is that? It is because competition in this
service sector is generally high and promotions is necessary to
survive. Thus banks, IT companies, and dotcoms place themselves
above the rest by advertising or promotions.
Pricing – Pricing in case of services is rather more difficult than in
case of products. If you were a restaurant owner, you can price people
only for the food you are serving. But then who will pay for the nice
ambience you have built up for your customers? Who will pay for the
band you have for music? Thus these elements have to be taken into
consideration while costing. Generally service pricing involves taking
into consideration labor, material cost and overhead costs. By adding

a profit mark-up, you get your final service pricing. You can also read
about pricing strategies.
People – People is one of the elements of service marketing mix.
People define a service. If you have an IT company, your software
engineers define you. If you have a restaurant, your chef and service
staff define you. If you are into banking, employees in your branch
and their behaviour towards customers defines you. In case of service
marketing, people can make or break an organization. Thus, many
companies nowadays are involved into specially getting their staff
trained in interpersonal skills and customer service with a focus
towards customer satisfaction. In fact, many companies have to
undergo accreditation to show that their staff is better than the rest.
Definitely a USP in case of services.
Process – Service process is the way in which a service is delivered to
the end customer. Lets take the example of two very good companies
– McDonalds and FedEx. Both the companies thrive on their quick
service and the reason they can do that is their confidence on their
processes. On top of it, the demand of these services is such that they
have to deliver optimally without a loss in quality. Thus the process of
a service company in delivering its product is of utmost importance. It
is also a critical component in the service blueprint, wherein before
establishing the service, the company defines exactly what should be
the process of the service product reaching the end customer.
Physical Evidence – The last element in the service marketing mix is
a very important element. As said before, services are intangible in
nature. However, to create a better customer experience tangible
element are also delivered with the service. Take an example of a
restaurant which has only chairs and tables and good food, or a
restaurant which has ambient lighting, nice music along with good
seating arrangement and this also serves good food. Which one will
you prefer? The one with the nice ambience. That’s physical
evidence. Several times, physical evidence is used as a differentiator
in service marketing. Imagine a private hospital and a government
hospital. A private hospital will have plush offices and well-dressed
staff. Same cannot be said for a government hospital. Thus, physical
evidence acts as a differentiator.

.Product differentiation and positioning:
Differentiation is closely related to positioning. Differentiation is the
process companies use to make a product or service stand out from its
competitors in ways that provide unique value to the
customer. Differentiation is at work any time you're choosing between
two products in the same category.An effective positioning strategy
considers the strengths and weaknesses of the organization, the needs
of the customers and market and the position of competitors. The
purpose of a positioning strategy is that it allows a company to
spotlight specific areas where they can outshine and beat their
competition.
Consumer adoption process:
Philip Kotler considers five steps in consumer adoption process, such

as awareness, interest, evaluation, trial, and adoption. On the other
hand, William Stanton considers six steps, such as awareness stage,
interest and information stage, evaluation stage, trial stage, adoption
stage, and post-adoption stage. We will follow six steps.
1. Awareness Stage:Individual consumer becomes aware of the
innovation. He is exposed to innovation but knows very little
regarding the innovation. He has only limited information about it. He
is aware of either by discussion with friends, relatives, salesmen, or
dealers. He gets idea about a new product from various means of
advertising like newspapers, magazines, Internet, television, outdoor
media, etc. At this stage, he doesn’t give much attention to the new
product.

2. Interest and Information Stage:In this stage, the consumer becomes
interested in innovation and tries to collect more information. He
collects information from advertising media, salesmen, dealers,
current users, or directly from company. He tries to know about
qualities, features, functions, risk, producers, brand, colour, shape,
price, incentives, availability, services, and other relevant aspects.
Simply, he collects as much information as he can.
3. Evaluation Stage:Now, accumulated information is used to evaluate
the innovation. The consumer considers all the significant aspects to
judge the worth of innovation. He compares different aspects of
innovation like qualities, features, performance, price, after-sales
services, etc., with the existing products to arrive at the decision
whether the innovation should be tried out.
4. Trial Stage:Consumer is ready to try or test the new product. He
practically examines it. He tries out the innovation in a small scale to
get self-experience. He can buy the product, or can use free samples.
This is an important stage as it determines whether to buy it.
5. Adoption Stage:If trial produces satisfactory results, finally the
consumer decides to adopt/buy the innovation. He decides on
quantity, type, model, dealer, payment, and other issues. He purchases
the product and consumes individually or jointly with other members.
6. Post Adoption Behaviour Stage:This is the last stage of consumer
adoption. If a consumer satisfies with a new product and related
services, he continues buying it frequently, and vice-versa. He
becomes a regular user of innovation and also talks favourable to
others. This is a crucial step for a marketer.
In every stage of consumer adoption, a marketer is required to
facilitate consumers. He must take all possible actions to make them
try, buy, and repeat buy the innovation. Be clear that every type of
consumer (innovators, early adopters, early majority, late majority, or
laggards) follows all the stages of adoption process but takes different
amount of time to adopt the innovation.
Pricing:
Pricing is the process whereby a business sets the price at which it
will sell its products and services and may be part of the business's
marketing plan. In setting prices, the business will take into account

the price at which it could acquire the goods, the manufacturing cost,
the market place, competition, market condition, brand, and quality of
product.Pricing is also a key variable in microeconomic price
allocation theory. Pricing is a fundamental aspect of financial
modeling and is one of the four Ps of the marketing mix. (The other
three aspects are product, promotion, and place.) Price is the only
revenue generating element amongst the four Ps, the rest being cost
centers. However, the other Ps of marketing will contribute to
decreasing price elasticity and so enable price increases to drive
greater revenue and profits.Pricing can be a manual or automatic
process of applying prices to purchase and sales orders, based on
factors such as: a fixed amount, quantity break, promotion or sales
campaign, specific vendor quote, price prevailing on entry, shipment
or invoice date, combination of multiple orders or lines, and many
others. Automated systems require more setup and maintenance but
may prevent pricing errors. The needs of the consumer can be
converted into demand only if the consumer has the willingness and
capacity to buy the product. Thus, pricing is the most important
concept in the field of marketing, it is used as a tactical decision in
response to comparing market situation.
Objectives of pricing:
The objectives of pricing should include:
 to achieve the financial goals of the company (i.e. profitability)
 to fit the realities of the marketplace (will customers buy at that
price?)
 to support a product's market positioning and be consistent with
the other variables in the marketing mix
 price is influenced by the type of distribution channel used, the
type of promotions used, and the quality of the product
 price will usually need to be relatively high if manufacturing is
expensive, distribution is exclusive, and the product is supported by
extensive advertising and promotional campaigns
 a low cost price can be a viable substitute for product quality,
effective promotions, or an energetic selling effort by distributors
From the marketer's point of view, an efficient price is a price that is
very close to the maximum that customers are prepared to pay. In
economic terms, it is a price that shifts most of the consumer
economic surplus to the producer. A good pricing strategy would be
the one which could balance between the price floor (the price below
which the organization ends up in losses) and the price ceiling (the
price be which the organization experiences a no-demand situation).
Factors affecting pricing:
1. Price-quality relationship:Customers use price as an indicator of
quality, particularly for products where objective measurement of
quality is not possible, such as drinks and perfumes. Price strongly
influences quality perceptions of such products.If a product is priced
higher, the instinctive judgment of the customer is that the quality of
the product must be higher, unless he can objectively justify
otherwise.
2. Product line pricing:A company extends its product line rather than
reduce price of its existing brand, when a competitor launches a low
price brand that threatens to eat into its market share. It launches a
low price fighter brand to compete with low price competitor
brands.The company is able to protect the image of its premium
brand, which continues to be sold at a higher price. At a later stage, it
produces a range of brands at different price points, which serve
segments of varying price sensitivities.And when a customer shows
the inclination to trade up, it persuades him to buy one of its own
premium brands. Similarly, if a customer of one of its premium
brands wants to trade down, it encourages him to buy one of its value
brands.But, it is not easy to maintain a portfolio of brands in the same
product category. The company needs to endow each of its brands
with an independent personality, and identify it with a segment.A
company’s brands should not be floating around, willing to grab any
customer that they can, but they should be specifically targeted at
segments—customers of the target segment should like the brand, but
customers of other segments should not like it enough to buy it.
3. Explicability:The company should be able to justify the price it is
charging, especially if it is on the higher side. Consumer product
companies have to send cues to the customers about the high quality
and the superiority of the product.A superior finish, fine aesthetics or
superior packaging can give positive cues to the customers when they

cannot objectively measure the quality of the offering. A company
should be aware of the features of the product that the customers can
objectively evaluate and should ensure superior performance of those
features.In industrial markets, the capability of salespeople to explain
a high price to customers may allow them to charge higher prices.
Where customers demand economic justifications of prices, the
inability to produce cost arguments may mean that high price cannot
be charged.A customer may reject a price that does not seem to reflect
the cost of producing the product. Sometimes it may have to be
explained that premium price was needed to cover R&D expenditure,
the benefits of which the customer is going to enjoy.
4. Competition:A company should be able to anticipate reactions of
competitors to its pricing policies and moves. Competitors can negate
the advantages that a company might be hoping to make with its
pricing policies. A company reduces its price to gain market
share.One or more competitors can decide to match the cut, thwarting
the ambitions of the company to gamer market share. But all
competitors are not same and their approaches and reactions to
pricing moves of the company are different.The company has to take
care while defining competition. The first level of competitors offers
technically similar products. There is direct competition between
brands which define their businesses and customers in similar
way.Reactions of such competitors are very swift and the company
will have to study each of its major competitors and find out their
business objectives and cash positions.Competitors who have similar
ambitions to increase their market share and have deep pockets will
swiftly reduce price if any one of them reduces prices. A telephone
company offering landline services has all telephone companies
offering landline services as its first level of competitors.The second
level of competition is dissimilar products serving the same need in a
similar way. Such competitors’ initial belief is that they are not being
affected by the pricing moves of the company.But once it sinks in that
they are being affected adversely by the pricing moves of a company
that seemingly belongs to another industry, they will take swift
retaliatory actions. The telephone company has the mobile phone
operators as its second level of competitors.The third level of

competition would come from products serving the problem in a
dissimilar way. Again such competitors do not believe that they will
be affected. But once convinced that they are being affected
adversely, swift retaliation should be expected.The retaliation of third
level is difficult to comprehend as their business premises and cost
structures are very different from the company in question.
Companies offering e-mail service are competitors at the third level of
the telephone company. A company must take into account all three
levels of competition.
5. Negotiating margins:A customer may expect its supplier to reduce
price, and in such situations the price that the customer pays is
different from the list price. Such discounts are pervasive in business
markets, and take the form of order-size discounts, competitive
discounts, fast payment discounts, annual volume bonus and
promotions allowance.Negotiating margins should be built, which
allow price to fall from list price levels but still permit profitable
transactions. It is important that the company anticipates the discounts
that it will have to grant to gain and retain business and adjust its list
price accordingly. If the company does not build potential discounts
into its list price, the discounts will have to come from the company’s
profits.
6. Effect on distributors and retailers:When products are sold through
intermediaries like retailers, the list price to customers must reflect the
margins required by them Sometimes list prices will be high because
middlemen want higher margins.But some retailers can afford to sell
below the list price to customers. They run low-cost operations and
can manage with lower margins. They pass on some part of their own
margins to customers.
7. Political factors:Where price is out of line with manufacturing
costs, political pressure may act to force down prices. Exploitation of
a monopoly position may bring short term profits but incurs backlash
of a public enquiry into pricing policies. It may also invite customer
wrath and cause switching upon the introduction of suitable
alternatives.
8. Earning very high profits:It is never wise to earn extraordinarily
profits, even if current circumstances allow the company to charge

high prices. The pioneer companies are able to charge high prices, due
to lack of alternatives available to the customers.
The company’s high profits lure competitors who are enticed by the
possibility of making profits. The entry of competitors in hordes puts
tremendous pressure on price and the pioneer company is forced to
reduce its price. But if the pioneer had been satisfied with lesser
profits, the competitors would have kept away for a longer time, and
it would have got sufficient time to consolidate its position.
9. Charging very low prices:It may not help a company’s cause if it
charges low prices when its major competitors are charging much
higher prices. Customers come to believe that adequate quality can be
provided only at the prices being charged by the major companies.If a
company introduces very low prices, customers suspect its quality and
do not buy the product in spite of the low price. If the cost structure of
the company allows, it should stay in business at the low price.
Slowly, as some customers buy the product, they spread the news of
its adequate quality.
The customers’ belief about the quality-price equation starts
changing. They start believing that adequate quality can be provided
at lower prices. The companies which have been charging higher
prices come under fire from customers. They either have to reduce
their prices or quit.
Pricing methods:
Cost-plus pricing - Set the price at your production cost, including
both cost of goods and fixed costs at your current volume, plus a
certain profit margin. For example, your widgets cost $20 in raw
materials and production costs, and at current sales volume (or
anticipated initial sales volume), your fixed costs come to $30 per
unit. Your total cost is $50 per unit. You decide that you want to
operate at a 20% markup, so you add $10 (20% x $50) to the cost and
come up with a price of $60 per unit. So long as you have your costs
calculated correctly and have accurately predicted your sales volume,
you will always be operating at a profit.
Target return pricing - Set your price to achieve a target return-on-
investment (ROI). For example, let's use the same situation as above,
and assume that you have $10,000 invested in the company. Your

expected sales volume is 1,000 units in the first year. You want to
recoup all your investment in the first year, so you need to make
$10,000 profit on 1,000 units, or $10 profit per unit, giving you again
a price of $60 per unit.
Value-based pricing - Price your product based on the value it creates
for the customer. This is usually the most profitable form of pricing, if
you can achieve it. The most extreme variation on this is "pay for
performance" pricing for services, in which you charge on a variable
scale according to the results you achieve. Let's say that your widget
above saves the typical customer $1,000 a year in, say, energy costs.
In that case, $60 seems like a bargain - maybe even too cheap. If your
product reliably produced that kind of cost savings, you could easily
charge $200, $300 or more for it, and customers would gladly pay it,
since they would get their money back in a matter of months.
However, there is one more major factor that must be considered.
Psychological pricing - Ultimately, you must take into consideration
the consumer's perception of your price, figuring things like:
Positioning - If you want to be the "low-cost leader", you must be
priced lower than your competition. If you want to signal high quality,
you should probably be priced higher than most of your competition.
Popular price points - There are certain "price points" (specific prices)
at which people become much more willing to buy a certain type of
product. For example, "under $100" is a popular price point. "Enough
under $20 to be under $20 with sales tax" is another popular price
point, because it's "one bill" that people commonly carry. Meals under
$5 are still a popular price point, as are entree or snack items under $1
(notice how many fast-food places have a $0.99 "value menu").
Dropping your price to a popular price point might mean a lower
margin, but more than enough increase in sales to offset it.
Fair pricing - Sometimes it simply doesn't matter what the value of
the product is, even if you don't have any direct competition. There is
simply a limit to what consumers perceive as "fair". If it's obvious that
your product only cost $20 to manufacture, even if it delivered
$10,000 in value, you'd have a hard time charging two or three
thousand dollars for it -- people would just feel like they were being

gouged. A little market testing will help you determine the maximum
price consumers will perceive as fair.
Pricing strategies:
Price change:
The difference in the cost of an asset or security from one period to
another. While it can be computed for any length of time, the most
commonly cited price change in the financial media is the "daily price
change", which is the change in the price of a stock or security from
the previous trading day's close to the current day's close. Price
change over a period of time such as year-to-date or past 12 months
are also commonly used time periods, and is generally computed as a
percentage change.

Unit 3:
Supply chain:
Supply chain management (SCM) is the management of the flow of
goods and services. It includes the movement and storage of raw
materials, work-in-process inventory, and finished goods from point
of origin to point of consumption. Interconnected or interlinked
networks, channels and node businesses are involved in the provision
of products and services required by end customers in a supply chain.
Supply chain management has been defined as the "design, planning,
execution, control, and monitoring of supply chain activities with the
objective of creating net value, building a competitive infrastructure,
leveraging worldwide logistics, synchronizing supply with demand
and measuring performance globally."
SCM draws heavily from the areas of operations management,
logistics, procurement, and information technology, and strives for an
integrated approach.
Nature of supply chain:
Inventory
Cost
Information
Customer services
Supply chain collaborations
Types of supply chain:
Types of Supply Chain Management (SCM) Systems depending on
the functions the supply chain management systems perform, they are
classified into two categories, namely supply chain planning systems
and supply chain execution systems.
Supply Chain Planning Systems
These systems provide information that help businesses in the
planning of their supply chain. Some of the important supply chain
planning functions are as follows:
Forecasting demand for specific products and preparing sourcing and
manufacturing plan for those products.
Estimating the quantity of the product to be manufactured in a given
time period
Deciding the location where the finished goods are to be stored

Identifying the transportation mode to be used for delivering the
products
Setting the inventory levels for raw materials, intermediate products,
and finished goods
Determining the product quantity a business should make in order to
meet all its customers’ demands
Supply Chain Execution Systems
These systems provide information that help businesses in the
execution of their supply chain steps. Some of the major supply chain
execution functions are as follows:
Managing the flow of products from the manufacturers to distributors
to retailers and finally to customers in order to ensure the accurate
delivery of products
Providing information about the status of orders being processed so
that the vendors could provide the exact delivery dates to customers.
Tracking the shipment and accounting for the products that have been
returned or are to be repaired and serviced
Benefits of Supply Chain Management (SCM)
1. Effective Supply Chain Management (SCM) systems is
beneficial to optimize the organization’s performance.
2. Improve the customer service by delivering them the right
product at the right time and at the right location, which in tum
increases the organization’s sales.
3. Enable the companies to bring the products to the market at a
quicker rate. Thus, the companies get their payment sooner than those
who lack an efficient supply chain.
4. Lower the total supply chain cost, including procuring materials
cost, transportation cost, inventor, carrying cost,etc. The reduction in
supply chain cost helps to increase the firm’s profitability.
Channel design and channel management decisions:
Channel Management. Yet another sales and marketing phrase that is
thrown around like everyone knows what it means. But so few
companies really comprehend channel management in a way that
really helps them. It’s really no wonder. Sales channels (being the
conduits by which we distribute our products to the end-user) come in
many shapes—from direct, to the web, to the traditional retail

environment. And, we’re just doing whatever we can to get any
business from any of them! But is that the most efficient and effective
approach?
That’s where Channel Management comes in. Channel management,
as a process by which a company creates formalized programs for
selling and servicing customers within a specific channel, can really
impact your business—and in a positive way! To get started, first
segment your channels by like characteristics (their needs, buying
patterns, success factors, etc.) and then customize a channel
management program that includes:
Goals. Define the specific goals you have for each channel segment.
Consider your goals for the channel as a whole as well as individual
accounts. And, remember to consider your goals for both acquisition
and retention.
Policies. Construct well-defined polices for administering the
accounts within this channel. Be sure to keep the unique
characteristics of each segment in mind when defining policies for
account set up, order management, product fulfillment, etc.
Products. Identify which products in your offering are most suited for
each segment and create appropriate messaging. Also, determine
where your upsell opportunities lie.
Sales/Marketing Programs. Design support programs for your channel
that meet THEIR needs, not what your idea of their needs are. To do
this, you should start by asking your customers within this segment,
“how can we best support you in the selling and marketing of our
products?” That being said, the standard considerations are product
training, co-op advertising, seasonal promotions, and merchandising.
Again, this is not a one-size fits all, so be diligent about addressing
this segment’s SPECIFIC needs in these areas.
Defining a channel management strategy for each segment allows you
to be more effective within each segment, while gaining efficiency at
the same time. Still, maintaining brand consistency across all channel
segments is critical to your long-term success. So find a good balance
between customization and brand consistency and you’ll be on your
way to successful channel management.
Channels of distributions:

The distribution function of marketing is comparable to the place
component of the marketing mix in that both center on getting the
goods from the producer to the consumer. A distribution channel in
marketing refers to the path or route through which goods and/or
services travel to get from the place of production or manufacture to
the final users. It has at its center, transportation and logistical
considerations.
Business-to-Business (B2B) Distribution Channels
Business-to-business (B2B) distribution occurs between a producer
and industrial users of raw materials needed for the manufacturer of
finished products. For example, a logging company needs a
distribution system to connect it with the lumber manufacturer who
makes wood for buildings and furniture.
Business-to-Customer (B2C)
Business-to-customer (B2C) distribution occurs between the producer
and the final user. For instance, the lumber manufacturer who sells
lumber to the furniture maker, who then makes the furniture and sells
it to retail stores, who then sells to the final customer.
Types of Distribution Channels
In marketing, goods can be distributed using two main types of
channels, direct distribution channels and indirect distribution
channels.
Direct Distribution
A distribution system is said to be direct when the product or service
leaves the producer and goes directly to the customer, with no
middlemen involved. This occurs, more often than not, with the sale
of services. For example, both the car wash and the barber utilize
direct distribution because the customer receives the service directly
from the producer. This can also occur with organizations that sell
tangible goods, such as the jewelry manufacturer who sells its
products directly to consumer.
Indirect Distribution
Indirect distribution occurs when there are middlemen or
intermediaries within the distribution channel. In the wood example,
the intermediaries would be the lumber manufacturer, the furniture
maker, and the retailer. The larger the number of intermediaries

within the channel, the higher the price is likely to be for the final
customer. This is because of the value adding that occurs at each step
within the structure.
Intermediaries
Direct or indirect distribution structures may include any combination
or all of the following entities:
Retailing:
Retail is the process of selling consumer goods and/or services to
customers through multiple channels of distribution to earn a profit.
Demand is created through diverse target markets and promotional
tactics, satisfying consumers' wants and needs through a lean supply
chain. In the 2000s, an increasing amount of retailing is done online
using electronic payment and delivery via a courier or postal mail.
Retailing includes subordinated services, such as delivery. The term
"retailer" is also applied where a service provider services the small
orders of a large number of individuals, rather than large orders of a
small number of wholesale, corporate or government clientele. Shops
may be on residential streets, streets with few or no houses, or in a
shopping mall. Shopping streets may be for pedestrians only.
Sometimes a shopping street has a partial or full roof to create a more
comfortable shopping environment protecting customers from various
types of weather conditions such as extreme temperatures, winds or
precipitation. Online retailing, a type of electronic commerce used for
business-to-consumer (B2C) transactions and mail order, are forms of
non-shop retailing.
Shopping generally refers to the act of buying products. Sometimes
this is done to obtain final goods including necessities such as food
and clothing; sometimes it is done as a recreational activity.
Recreational shopping often involves window shopping (just looking,
not buying) and browsing and does not always result in a purchase.
Wholesaling:
Wholesaling, jobbing, or distributing is the sale of goods or
merchandise to retailers; to industrial, commercial, institutional, or
other professional business users; or to other wholesalers and related
subordinated services.In general, it is the sale of goods to anyone
other than a standard consumer.
According to the United Nations Statistics Division, "wholesale" is
the resale (sale without transformation) of new and used goods to
retailers, to industrial, commercial, institutional or professional users,
or to other wholesalers, or involves acting as an agent or broker in
buying merchandise for, or selling merchandise to, such persons or
companies. Wholesalers frequently physically assemble, sort and
grade goods in large lots, break bulk, repack and redistribute in
smaller lots. While wholesalers of most products usually operate from
independent premises, wholesale marketing for foodstuffs can take
place at specific wholesale markets where all traders are congregated.
Traditionally, wholesalers were closer to the markets they supplied
than the source from which they got the products. However, with the
advent of the internet and e-procurement there are an increasing
number of wholesalers located nearer to the manufacturers in China,
Taiwan, and Southeast Asia.
In the banking industry "wholesale" usually refers to wholesale
banking, providing tailored services to large customers, in contrast
with retail banking, providing standardized services to large numbers
of smaller customers.
Logistics:

Logistics is the management of the flow of things between the point
of origin and the point of consumption in order to meet requirements
of customers or corporations. The resources managed in logistics can
include physical items, such as food, materials, animals, equipment
and liquids, as well as abstract items, such as time and information.
The logistics of physical items usually involves the integration of
information flow, material handling, production, packaging,
inventory, transportation, warehousing, and often security.In military
science, logistics is concerned with maintaining an army supply lines
while disrupting those of the enemy, since an armed force without
resources and transportation is defenceless. Military logistics was
already practiced in the ancient world and as modern military have a
significant need for logistics solutions, advanced implementations
have been developed, especially for the United States Armed Forces.
In military logistics, logistics officers manage how and when to move
resources to the places they are needed.Logistics management is the
part of supply chain management that plans, implements, and controls
the efficient, effective forward, and reverse flow and storage of goods,
services, and related information between the point of origin and the
point of consumption in order to meet customer's requirements. The
complexity of logistics can be modeled, analyzed, visualized, and
optimized by dedicated simulation software. The minimization of the
use of resources is a common motivation in all logistics fields. A
professional working in the field of logistics management is called a
logistician.
Business logistics
One definition of business logistics speaks of "having the right item in
the right quantity at the right time at the right place for the right price
in the right condition to the right customer". Business logistics
incorporates all industry sectors and aims to manage the fruition of
project life cycles, supply chains, and resultant efficiencies.
The term "business logistics" has evolved since the 1960s due to the
increasing complexity of supplying businesses with materials and
shipping out products in an increasingly globalized supply chain,
leading to a call for professionals called "supply chain logisticians".

In business, logistics may have either an internal focus (inbound
logistics) or an external focus (outbound logistics), covering the flow
and storage of materials from point of origin to point of consumption
(see supply-chain management). The main functions of a qualified
logistician include inventory management, purchasing, transportation,
warehousing, consultation, and the organizing and planning of these
activities. Logisticians combine a professional knowledge of each of
these functions to coordinate resources in an organization.
There are two fundamentally different forms of logistics: one
optimizes a steady flow of material through a network of transport
links and storage nodes, while the other coordinates a sequence of
resources to carry out some project (ex:restructuring a warehouse).
Nodes of a distribution network
The nodes of a distribution network include:
Factories where products are manufactured or assembled
A depot or deposit is a standard type of warehouse thought for storing
merchandise (high level of inventory).
Distribution centers are for order processing and order fulfillment
(lower level of inventory) and also for receiving returning items from
clients.
Transit points are built for cross docking activities, which consist in
reassembling cargo units based on deliveries scheduled (only moving
merchandise).
Traditional retail stores of the Mom and Pop variety, modern
supermarkets, hypermarkets, discount stores or also voluntary chains,
consumer cooperative, groups of consumer with collective buying
power. Note that subsidiaries will be mostly owned by another
company and franchisers, although using other company brands,
actually own the point of sale.
Promotion :
Promotion refers to raising customer awareness of a product or brand,
generating sales, and creating brand loyalty. It is one of the four basic
elements of the market mix, which includes the four P's: price,
product, promotion, and place.
Promotion is also defined as one of five pieces in the promotional mix
or promotional plan. These are personal selling, advertising, sales

promotion, direct marketing, and publicity. A promotional mix
specifies how much attention to pay to each of the five factors, and
how much money to budget.
Fundamentally, there are three basic objectives of promotion. These
are:
To present information to consumers and others.
To increase demand.
To differentiate a product.
The purpose of a promotion and thus its promotional plan can have a
wide range, including: sales increases, new product acceptance,
creation of brand equity, positioning, competitive retaliations, or
creation of a corporate image.
The term promotion is usually an "in" expression used internally by
the marketing company, but not normally to the public or the market,
where phrases like "special offer" are more common. Examples of a
fully integrated, long-term, and large-scale promotion are My Coke
Rewards in the U.S. or Coke Zone in the UK and Pepsi Stuff.
Types
There have been different ways to promote a product in person or
with different media. Both person and media can be either physically
real or virtual /electro
In a physical environment :Promoters have used newspapers, special
events, endorsements, Promotions can be held in physical
environments at special events such as concerts, festivals, trade
shows, and in the field, such as in grocery or department stores.
Interactions in the field allow immediate purchases. The purchase of a
product can be incentive with discounts (i.e., coupons), free items, or
a contest. This method is used to increase the sales of a given product.
Interactions between the brand and the customer are performed by a
brand ambassador or promotional model who represents the product
in physical environments. Brand ambassadors or promotional models
are hired by a marketing company, which in turn is booked by the
brand to represent the product or service. Person-to-person
interaction, as opposed to media-to-person involvement, establishes
connections that add another dimension to promotion. Building a

community through promoting goods and services can lead to brand
loyalty.
Traditional media: Examples of traditional media include print media
such as newspapers and magazines, electronic media such as radio
and television, and outdoor media such as banner or billboard
advertisements. Each of these platforms provide ways for brands to
reach consumers with advertisements.
Digital media :Digital media, which includes Internet, social
networking and social media sites, is a modern way for brands to
interact with consumers as it releases news, information and
advertising from the technological limits of print and broadcast
infrastructures. Digital media is currently the most effective way for
brands to reach their consumers on a daily basis. Over 2.7 billion
people are online globally, which is about 40% of the world's
population.67% of all Internet users globally use social media.
Mass communication has led to modern marketing strategies to
continue focusing on brand awareness, large distributions and heavy
promotions. The fast-paced environment of digital media presents
new methods for promotion to utilize new tools now available
through technology. With the rise of technological advances,
promotions can be done outside of local contexts and across
geographic borders to reach a greater number of potential consumers.
The goal of a promotion is then to reach the most people possible in a
time efficient and a cost efficient manner.
Social media, as a modern marketing tool, offers opportunities to
reach larger audiences in an interactive way. These interactions allow
for conversation rather than simply educating the customer.
Facebook, Twitter, LinkedIn, Pinterest, Google Plus, Tumblr and
Instagram are rated as some of the most popular social networking
sites.As a participatory media culture, social media platforms or social
networking sites are forms of mass communication that, through
media technologies, allow large amounts of product and distribution
of content to reach the largest audience possible. However, there are
downsides to virtual promotions as servers, systems, and websites
may crash, fail, or become overloaded.

Brands can explore different strategies to keep consumers engaged.
One popular tool is branded entertainment, or creating some sort of
social game for the user. The benefits of such a platform include
submersing the user in the brand's content. Users will be more likely
to absorb and not grow tired of advertisements if they are, for
example, embedded in the game as opposed to a bothersome pop-up
ad.
Personalizing advertisements is another strategy that can work well
for brands, as it can increase the likelihood that the brand will be
anthropomorphized by the consumer. Personalization increases click-
through intentions when data has been collected about the consumer.
Brands must navigate the line between effectively promoting their
content to consumers on social media and becoming too invasive in
consumers' lives. Vivid Internet ads that include devices such as
animation might increase a user's initial attention to the ad. However,
this may be seen as a distraction to the user if they are trying to absorb
a different part of the site such as reading text. Additionally, when
brands make the effort of overtly collecting data about their
consumers and then personalizing their ads to them, the consumer's
relationship with the advertisements, following this data collection, is
frequently positive. However, when data is covertly collected,
consumers can quickly feel like the company betrayed their trust. It is
important for brands to utilize personalization in their ads, without
making the consumer feel vulnerable or that their privacy has been
betrayed.
Promotional activities to push a brand enabling social media channels
to spread content making something viral, such as the advertising by
Coke. Using the release of a new Bond film creating attention which
then gets promoted across all social channels by people spreading the
information due to excitement.
Communication process:
Lindsey is the supervisor of a team of employees in a research and
development department for a small tech company that focuses its
research on new apps. Her boss wants Lindsey to work on a new
project. But Lindsey can't successfully manage her team in order to
complete the project unless she is able to effectively communicate

with them. Communication is the process of conveying information
between two or more people. The communication process is the steps
we take in order to achieve a successful communication.
The communication process consists of several components.
A sender is the party that sends a message. Lindsey, of course, will be
the sender. She'll also need the message, which is the information to
be conveyed. Lindsey will also need to encode her message, which is
transforming her thoughts of the information to be conveyed into a
form that can be sent, such as words.A channel of communication
must also be selected, which is the manner in which the message is
sent. Channels of communication include speaking, writing, video
transmission, audio transmission, electronic transmission through
emails, text messages and faxes and even nonverbal communication,
such as body language. Lindsey also needs to know the target of her
communication. This party is called the receiver.The receiver must be
able to decode the message, which means mentally processing the
message into understanding. If you can't decode, the message fails.
For example, sending a message in a foreign language that is not
understood by the receiver probably will result in decoding
failure.Sometimes, a receiver will give the sender feedback, which is
a message sent by the receiver back to the sender. For example, a
member of Lindsey's team may provide feedback in the form a
question to clarify some information received in Lindsey's message.
Let's put all these components together to build a model of the
communication process:
A sender encodes information
The sender selects a channel of communication by which to send the
message
The receiver receives the message
The receiver decodes the message
The receiver may provide feedback to the sender
Promotional mix
In marketing, the promotional mix describes a blend of promotional
variables chosen by marketers to help a firm reach its goals. It has
been identified as a subset of the marketing mix. It is believed that
there is an optimal way of allocating budgets for the different

elements within the promotional mix to achieve best marketing
results, and the challenge for marketers is to find the right mix of
them. Activities identified as elements of the promotional mix vary,
but typically include the following:
Advertising is the paid presentation and promotion of ideas, goods,

or services by an identified sponsor in a mass medium. Examples
include print ads, radio, television, billboard, direct mail, brochures
and catalogues, signs, in-store displays, posters, mobile apps, motion
pictures, web pages, banner ads, emails.
Personal selling is the process of helping and persuading one or more
prospects to purchase a good or service or to act on any idea through
the use of an oral presentation, often in a face-to-face manner or by
telephone. Examples include sales presentations, sales meetings, sales
training and incentive programs for intermediary salespeople,
samples, and telemarketing.
Sales Promotion is media and non-media marketing communication
used for a pre-determined limited time to increase consumer demand,
stimulate market demand or improve product availability. Examples
include coupons, sweepstakes, contests, product samples, rebates, tie-
ins, self-liquidating premiums, trade shows, trade-ins, and exhibitions.
Public relations or publicity is information about a firm's products
and services carried by a third party in an indirect way. This includes
free publicity as well as paid efforts to stimulate discussion and
interest. It can be accomplished by planting a significant news story
indirectly in the media, or presenting it favourably through press
releases or corporate anniversary parties. Examples include
newspaper and magazine articles, TVs and radio presentations,
charitable contributions, speeches, issue advertising, seminars.

Direct Marketing is a channel-agnostic form of advertising that
allows businesses and non-profits to communicate directly to the
customer, with methods such as mobile messaging, email, interactive
consumer websites, online display ads, fliers, catalogue distribution,
promotional letters, and outdoor advertising.
Corporate image campaigns have been considered as part of the
promotional mix.
Sponsorship of an event or contest or race is a way to generate further
positive publicity.
Guerrilla marketing tactics are unconventional ways to bring attention
to an idea or product or service, such as by using graffiti, sticker
bombing, posting flyers, using flash mobs, doing viral marketing
campaigns, or other methods using the Internet in unexpected ways.
Product placement is paying a movie studio or television show to
include a product or service prominently in the show.
Advertising:
Advertising is a form of marketing communication used to promote
or sell something, usually a business's product or service. It is a paid
form of promotion. Advertising messages are usually paid for by
sponsors and viewed via various old media; including mass media
such as newspaper, magazines, television advertisement, radio
advertisement, outdoor advertising or direct mail; or new media such
as blogs, websites or text messages.Commercial ads seek to generate
increased consumption of their products or services through
"branding," which associates a product name or image with certain
qualities in the minds of consumers. Non-commercial advertisers who
spend money to advertise items other than a consumer product or
service include political parties, interest groups, religious
organizations and governmental agencies. Non-profit organizations
may use free modes of persuasion, such as a public service
announcement (PSA).Modern advertising was created with the
techniques introduced with tobacco advertising in the 1920s, most
significantly with the campaigns of Edward Bernays, considered the
founder of modern, "Madison Avenue" advertising.
Hierarchy-of-effects models

Various competing models of hierarchies of effects attempt to provide
a theoretical underpinning to advertising practice.The model of Clow
and Baack clarifies the objectives of an advertising campaign and for
each individual advertisement. The model postulates six steps a buyer
moves through when making a purchase:
Awareness
Knowledge
Liking
Preference
Conviction
Purchase
Means-End Theory suggests that an advertisement should contain a
message or means that leads the consumer to a desired end-state.
Leverage Points aim to move the consumer from understanding a
product's benefits to linking those benefits with personal values.
AIDA MODEL:
AIDA is an acronym used in marketing and advertising that describes

a common list of events that may occur when a consumer engages
with an advertisement.
A – attention (awareness): attract the attention of the customer.
I – interest of the customer.
D – desire: convince customers that they want and desire the product
or service and that it will satisfy their needs.
A – action: lead customers towards taking action and/or purchasing.
Using a system like this gives one a general understanding of how to
target a market effectively. Moving from step to step, one loses some
percent of prospects.

AIDA is a historical model, rather than representing current thinking
in the methods of advertising effectiveness
Sales promotion:
Sales promotion is one of the five aspects of the promotional mix.
(The other 4 parts of the promotional mix are advertising, personal
selling, direct marketing and publicity/public relations.) Media and
non-media marketing communication are employed for a pre-
determined, limited time to increase consumer demand, stimulate
market demand or improve product availability. Examples include
contests, coupons, freebies, loss leaders, point of purchase displays,
premiums, prizes, product samples, and rebates.
Sales promotions can be directed at either the customer, sales staff, or
distribution channel members (such as retailers). Sales promotions
targeted at the consumer are called consumer sales promotions. Sales
promotions targeted at retailers and wholesale are called trade sales
promotions. Some sale promotions, particularly ones with unusual
methods, are considered gimmicks by many.
Sales promotion includes several communications activities that
attempt to provide added value or incentives to consumers,
wholesalers, retailers, or other organizational customers to stimulate
immediate sales. These efforts can attempt to stimulate product
interest, trial, or purchase. Examples of devices used in sales
promotion include coupons, samples, premiums, point-of-purchase
(POP) displays, contests, rebates, and sweepstakes.
Sales promotion is implemented to attract new customers, to hold
present customers, to counteract competition, and to take advantage of
opportunities that are revealed by market research. It is made up of
activities, both outside and inside activities, to enhance company
sales. Outside sales promotion activities include advertising,
publicity, public relations activities, and special sales events. Inside
sales promotion activities includes window displays, product and
promotional material display and promotional programs such as
premium awards and contests.
Sale promotions often come in the form of discounts. Discounts
impact the way consumers think and behave when shopping. The type
of savings and its location can affect the way consumers view a

product and affect their purchase decision. The two most common
discounts are price discounts (“on sale items”) and bonus packs
(“bulk items”).Price discounts are the reduction of an original sale by
a certain percentage while bonus packs are deals in which the
consumer receives more for the original price.Many companies
present different forms of discounts in advertisements, hoping to
convince consumers to buy their products.
Types of sales promotion
Price deal: A temporary reduction in the price, such as 50% off.
Loyal Reward Program: Consumers collect points, miles, or credits
for purchases and redeem them for rewards.
Cents-off deal: Offers a brand at a lower price. Price reduction may be
a percentage marked on the package.
Price-pack/Bonus packs deal: The packaging offers a consumer a
certain percentage more of the product for the same price (for
example, 25 percent extra). This is another type of deal “in which
customers are offered more of the product for the same price”.[2] For
example, a sales company may offer their consumers a bonus pack in
which they can receive two products for the price of one. In these
scenarios, this bonus pack is framed as a gain because buyers believe
that they are obtaining a free product.[2] The purchase of a bonus
pack, however, is not always beneficial for the consumer. Sometimes
consumers will end up spending money on an item they would not
normally buy had it not been in a bonus pack. As a result, items
bought in a bonus pack are often wasted and is viewed as a “loss” for
the consumer.
Coupons: coupons have become a standard mechanism for sales
promotions.
Loss leader: the price of a popular product is temporarily reduced
below cost in order to stimulate other profitable sales
Free-standing insert (FSI): A coupon booklet is inserted into the local
newspaper for delivery.
Checkout dispensers: On checkout the customer is given a coupon
based on products purchased.

Mobile couponing: Coupons are available on a mobile phone.
Consumers show the offer on a mobile phone to a salesperson for
redemption.
Online interactive promotion game: Consumers play an interactive
game associated with the promoted product.
Rebates: Consumers are offered money back if the receipt and
barcode are mailed to the producer.
Contests/sweepstakes/games: The consumer is automatically entered
into the event by purchasing the product.
Point-of-sale displays:-
Aisle interrupter: A sign that juts into the aisle from the shelf.
Dangler: A sign that sways when a consumer walks by it.
Dump bin: A bin full of products dumped inside.
Bidding portals: Getting prospects
Glorifier: A small stage that elevates a product above other products.
Wobbler: A sign that jiggles.
Lipstick Board: A board on which messages are written in crayon.
Necker: A coupon placed on the 'neck' of a bottle.
YES unit: "your extra salesperson" is a pull-out fact sheet.
Electroluminescent: Solar-powered, animated light in motion.
Kids eat free specials: Offers a discount on the total dining bill by
offering 1 free kids meal with each regular meal purchased.
Sampling: Consumers get one sample for free, after their trial and
then could decide whether to buy or not.
Public relations:
Public relations (PR) is the practice of managing the spread of
information between an individual or an organization (such as a
business, government agency, or a non-profit organization) and the
public. Public relations may include an organization or individual
gaining exposure to their audiences using topics of public interest and
news items that do not require direct payment. This differentiates it
from advertising as a form of marketing communications. Public
relations is the idea of creating coverage for clients for free, rather
than marketing or advertising. An example of good public relations
would be generating an article featuring a client, rather than paying
for the client to be advertised next to the article.The aim of public

relations is to inform the public, prospective customers, investors,
partners, employees and other stakeholders and ultimately persuade
them to maintain a certain view about the organization, its leadership,
products, or political decisions. Public relations professionals
typically work for PR and marketing firms, businesses and
companies, government, government agencies and public officials as
PIOs and nongovernmental organizations and non-profit
organizations.
Direct selling:
Direct selling is the marketing and selling of products directly to
consumers away from a fixed retail location. Peddling is the oldest
form of direct selling. Modern direct selling includes sales made
through the party plan, one-on-one demonstrations, and other personal
contact arrangements as well as internet sales. A textbook definition
is: "The direct personal presentation, demonstration, and sale of
products and services to consumers, usually in their homes or at their
jobs." Direct marketing is about business organizations seeking a
relationship with their customers without going through an
agent/consultant or retail outlet.Direct selling consists of two main
business models: single-level marketing, in which a direct seller
makes money by buying products from a parent organization and
selling them directly to customers, and multi-level marketing (also
known as network marketing or person-to-person marketing), in
which the direct seller makes money from both direct sales to
customers and by sponsoring new direct sellers and earning a
commission from their efforts.
Online marketing:
Online advertising, also called online marketing or Internet
advertising or web advertising, is a form of marketing and advertising
which uses the Internet to deliver promotional marketing messages to
consumers. It includes email marketing, search engine marketing
(SEM), social media marketing, many types of display advertising
(including web banner advertising), and mobile advertising. Like
other advertising media, online advertising frequently involves both a
publisher, who integrates advertisements into its online content, and
an advertiser, who provides the advertisements to be displayed on the

publisher's content. Other potential participants include advertising
agencies who help generate and place the ad copy, an ad server which
technologically delivers the ad and tracks statistics, and advertising
affiliates who do independent promotional work for the advertiser.
Online advertising is widely used across virtually all industry
sectors.Many common online advertising practices are controversial
and increasingly subject to regulation. Online ad revenues may not
adequately replace other publishers' revenue streams. Declining ad
revenue has led some publishers to hide their content behind
paywalls.
Personal selling:
In the language of sales and marketing, "personal selling" singles out
those situations in which a real human being is trying to sell
something to another face-to-face. One might well ask what other
type of genuine selling there is. The answer is that personal selling
has a functional equivalent. The modern differentiation between
"personal" and other selling arises from the fact that a very substantial
volume of ordinary purchasing of food, textiles, household goods,
entertainment, travel, subscriptions, fuel, books, etc., takes place
without the presence of a live facilitator. The only human contact is
usually the check-out clerk; and corporations are laboring hard to
replace even this humble functionary by machines that read barcodes
and recognize credit cards. In the vast majority of these situations
whatever persuasion has been applied to the shopper has been
delivered by disembodied images on television, radio, in print, by
coupons, by signage, and by packaging. Thus "impersonal selling" is
by advertising, sales promotion and public relations.
THE BUYING-SELLING SITUATION
In personal life few people buy a house, a car, or a life insurance
policy after reading an ad or looking at a flashy brochure left hanging
on the door knob. Major work on the house is approved after personal
selling has taken place—and so does the choice of a retirement village
for a grandparent. These situations, first of all, are not routine
occurrences; second, they are transactions of some magnitude; third,
many choices are usually available; one might say that the situations
have a high "information density." In these cases interacting with the

seller's knowledgeable representative in a prolonged exploratory give-
and-take is both necessary and reassuring. Indeed, arguably, personal
selling is also helpful when making smaller purchases provided that
the decision is difficult for the buyer, as in a bride-to-be selecting a
wedding gown or a man purchasing jewellery for his wife's birthday.
In certain categories of retail—luggage stores and furniture stores
come to mind—sales people are usually provided by the business, and
on busy days customers get fidgety when no one is there to help
them.In business-to-business buying and selling the same rules apply.
A business will typically obtain its office supplies from catalogues,
but most of its other purchases involve personal selling by the vendor
even if buying the commodity or services later becomes routine; in
the latter cases, periodic calls from the sales person will continue to
maintain the relationship. Business purchases are very often
"technical" in nature, not necessarily because the goods are
mechanical or electronic but because they have specialized aspects.
The psychological aspects of the buying-selling situation are
highlighted in the purchase of more expensive items. Buying
something is a decision in which the buyer must decide between
opposing tendencies. There is desire for the object and reasons lined
up to support a Yes. There is a cost involved and reasons present why
it should be avoided. The buyer must ultimately persuade him or
herself to say Yes or No. The importance of personal selling lies in
tilting the balance toward a Yes. Only an interactive situation gives
the seller this opportunity. Its abuse leads to—Negative Attitudes
In ancient times people feared that they would be cheated in sales
transactions, hence the Latin proverb, caveat emptor, meaning let the
buyer beware. From pre-industrial times comes the admonition not to
buy a "pig in a poke." Again the emphasis is on deception because a
"poke" is archaic for "bag." The hidden pig might have defects. We
say: "Don't look a gift horse in the mouth," implying that in a buying
situation looking at the horse's mouth (to determine its age from its
teeth) was highly recommended. The modern attitude toward direct
sales, however, emphasizes aggression or bullying with phrases like
"high-pressure sales" or "the hard sell." In the old days people only
bought what they genuinely wanted. The range of products competing

for buyers was limited; supplies were never very abundant—hence
people tried to move defective goods by deception. In our time great
surplus reigns; there is too much of everything. A good deal of
psychological force is routinely deployed to persuade people to buy,
on credit if necessary. The savings rate, consequently, has virtually
disappeared; people are in debt; and selling has acquired a negative
reputation—whether it is indirect like advertising or direct. In direct
selling telephone or door-to-door prospecting is particularly disliked
by the public.
CHARACTERISTICS OF SALESMANSHIP
The hard sell is unlikely to disappear until its cause does too, but
experts on salesmanship are virtually unanimous in viewing it as
negatively as the public. The job of the salesperson is to discover
what the buyer wants, to present the goods that match the desire as
closely as possible, to answer questions about the product (or service,
or contract, etc.), to deal effectively with objections, and finally to
close the sale. When this job is done correctly, the buyer will be well
served even if he or she does not buy.
The sales work is a complex activity in which many characteristics
must be simultaneously present, hence it is misleading to single out or
rank particular traits. The starting assumption, however, is that the
salesperson has integrity and will not sell something he or she knows
to be defective or inferior, will have character, honesty, and be
emotionally stable. Beyond that, the salesperson must have deep
product knowledge and good communications skills, must internalize
the customer's point of view, and must remain both unobtrusive and
yet accessible. He or she must have a good sense for all kinds of
people and a good sense of timing; thus he or she will know when to
attend and when to leave the customer alone, when to press and when
to withdraw. Salesmanship thus calls for a balanced, well rounded,
outgoing, and knowledgeable person. Some experts also emphasize
physical strength and energy—because sales work often requires
many hours of standing about, travel, and exertions of one sort or
another. Other emphasize a straightforward and candid attitude.
Problems with products or contract contingencies should be discussed

frankly. Pricing discussions should not be hedged. Maintenance issues
should be discussed with candor.
Selling and entrepreneurship have a good deal in common—indeed
are the same fundamental activity at the core. Both require active
engagement with the market environment. But while an entrepreneur
is often a person whose motivation springs from some type of interest,
body of knowledge, or cluster of skills, salesmanship often manifests
as a more generalized interest in interaction with the customer, so that
skilled sales people readily adapt to selling anything at all while some
entrepreneurs are only comfortable in narrow areas.
The very qualities that make sales people effective—enthusiasm for
working with people one-on-one—make some of them less effective
in activities that require patience, working alone, meticulous attention
to detail, and certain types of concentration. For this reason personal
selling staffs frequently require backup to ensure good order,
organization, and follow-through.
TYPES OF PERSONAL SELLING
Sales positions or their equivalents range between the sales clerk with
minimal selling skills up to the chief executive officer in public and in
private enterprises. At the bottom of the sales-pyramid the primary
skill is taking an order and guiding customers to the product; at the
top great ability to present complex, often controversial and abstract
cases persuasively, usually as just a part of other functions, is
required. Most personal selling takes place in the middle.
Sales positions are classified as "inside" and "outside." Inside sales
above the clerk level involve telephone sales, mainstream retail sales
in stores where product knowledge and presentation skills are
required, and auto sales and similar equipment sales where customers
visit the dealership. Inside sales may be combined with other
functions such as scheduling and early information gathering for an
outside agent.
Outside sales take place either at the prospective client's residence or
place of business or in a third-party location: real estate sales have
this form. Outside sales may be combined with estimating tasks as in
the case of bidding on construction work; it may also be combined
with product delivery. The driver-salesperson has a stocking function

sometimes combined with sales responsibilities. A special category is
the sales engineer highly skilled in some aspect of industrial
operations and thus able both to understand requirements and to
provide technical support.
In many types of financial, consulting, market research, engineering,
construction, and equipment sales categories personal selling may be
both inside and out. In the consulting industry the manager likely to
oversee a contract is likely to be the leading salesperson for the job. In
such situations buyers may call on the seller and vice-versa depending
on the circumstances.
Personal selling process
Steps in personal Selling process
Personal Selling consists of the following steps.
1.Pre-sale preparation: The first step in personal selling is the
selection, training and motivation of salespersons. The salespersons
must be fully familiar with the product, the firm, the market and the
selling techniques. They should be well-informed about the
competitor's products and the degree of competition. They should also
be acquainted with the motives and behavior of prospective buyers.
2.Prospecting: It refers to locating or searching out prospective buyers
who have the need for the product and the ability to buy it. Potential
customers may be spotted through observation, enquiry and analysis
of records of existing customers. Social contacts, business
associations and dealers can be helpful in the identification of
potential buyers.
3.Approaching : Before calling on the prospects, the salesperson
should fully learn their number, needs, habits, spending capacity,
motives, etc. Such knowledge helps in selecting the right sales appeal.
After such learning, the salesperson should approach the customer in
a polite and dignified way. He should introduce himself and his
product to the customer. He should greet the customer with a smile
and make him feel at home. He should introduce himself and his
product to the customer. In case he is busy with some other customer,
he should assure the new customer that he would be attended very
soon. The salesperson has to be very careful in his approach as the
first impression is the last impression.

4.Presentation: For this purpose, the salesperson has to present the
product and describe its features in brief. The presentation should be
matched with the attitude of the prospect so that the salesman can
continuously hold his attention and create interest in the product.
5.Demonstration: In order to maintain customer's interest and to
arouse his desire, the sales-person must display and demonstrate the
product. He has to explain the utility and distinctive qualities of the
product so that the prospect realizes the need for the product to satisfy
his wants. He should not be in a hurry to impress the customer and
should avoid controversy. He may suggest uses of the product and
may create an impulsive urge to possess the article by appealing to
human instincts.
6.Handling objections: A sale cannot be achieved simply by creating
interest and desire. Every customer wants to make the best bargain for
the money he is spending. Presentation and demonstration of the
product are likely to create doubts and questions in his mind. The
salesman should clear all doubts and objections without entering into
a controversy and without losing his temper. Testimonials, money-
back guarantee, tact and patience are popular means of winning over s
hesitant buyers. The salesman should convince the customer that he is
making the best use of his money by purchasing the product. For this
purpose, the salesman should prove the superiority of his product over
the competitive products. He should not lose patience if the customer
puts too many queries and takes time in arriving at any decision. If the
customer does not buy even after meeting rejections, the salesman
should let him go without showing temper. He must believe in the
universal rule that the customer is always right.
7.Closing the sale: This is the climax or critical point in the personal
selling process. Completing the sale seems to be an easy task but
inappropriate handling of the customer can result in loss of sale. The
salesman should not force the deal but let the customer feel that he
has made the final decision. He should guide the customer in making
the choice without imposing his own view. Some adjustment in price
or other concession may sometimes be necessary for a successful
closing. The salesman should show the same interest in the customer
which he exhibited during approach stage. Sales should be closed in a

cordial manner so that the customer feels inclined to visit the shop
again. In closing the sale, the article should be packed properly and
handed over to the customer with speed and accuracy. Once the
customer has purchased the article, the salesman should show and
suggest an allied product. For instance, he may suggest socks, ties,
handkerchiefs, vests, etc., to a customer purchasing a shirt. This is
known as additional sales and requires great skill and tact.
8.Post-sale follow-up : It refers to the activities undertaken to ensure
that the customer is satisfied with the article and the firm. These
activities include installation of the products, checking and ensuring
its smooth performance, maintenance and after-sale service. It helps
to secure repeat sales identify additional prospects and to evaluate
salesman's effectiveness.
Managing the sales force:
Sales force management systems are information systems used in
CRM marketing and management that help automate some sales and
sales force management functions. They are often combined with a
marketing information system, in which case they are often called
customer relationship management (CRM) systems.Sales force
management systems are essentially the same thing as sales force
automation system (SFA).A SFA, typically a part of a company’s
customer relationship management system, is a system that
automatically records all the stages in a sales process. SFA includes a
contact management system which tracks all contact that has been
made with a given customer, the purpose of the contact, and any
follow up that may be needed. This ensures that sales efforts are not
duplicated, reducing the risk of irritating customers. SFA also
includes a sales lead tracking system, which lists potential customers
through paid phone lists, or customers of related products. Other
elements of an SFA system can include sales forecasting, order
management and product knowledge. More developed SFA systems
have features where customers can actually model the product to meet
their needs through online product building systems. This is becoming
popular in the automobile industry, where patrons can customize
various features such as colour and interior features such as leather vs.
upholstered seats.An integral part of any SFA system is companywide

integration among different departments. If SFA systems aren’t
adopted and properly integrated to all departments, there might be a
lack of communication which could result in different departments
contacting the same customer for the same purpose. In order to
mitigate this risk, SFA must be fully integrated in all departments that
deal with customer service management.Making a dynamic sales
force links strategy and operational actions that can take place within
a department. the SFA relies on objectives, plans, budget, and control
indicators under specific conditions. In order to perform the
objectives correctly, specific procedures must be implemented:
Designing of the Sales Force
Sales force is linking between companies and customer. Therefore,
companies have to be careful in designing and structuring sales force.
The first step is setting out an objective for sales force. Earlier
companies had a single objective increasing sale making it objective
also for sales people. Sales people are asked to perform a search for
prospective clients or lead. Sales people are asked to balance time
between a prospective customer and current customer. Effective
communication of product and services is essential to close the deal.
Sales people also play an important role in after sales service and can
make a difference for the company. Sales people are eyes and ears of
the company in the market gathering information about competition
and customer changing demands.
The second step is use sales people strategically. Sales people have to
combine efforts with other team members to achieve the objective.
Sales people should be aware how to analyze market data been
provided and convert them into marketing strategies.
The third step is deciding the structure of the sales force. The
structure of the sales is dependent on the strategy followed by the
company. Common sales force structures are as follows:-
Territorial structure is used where every sales representative is
assigned specific geographical area. This structure is preferred for
building relationships with locals.
Product structure is used for complex and unrelated product
portfolio. Here the sales people are directly associated with research
and development of the products.

Market structure is used if the companies are operating different
industry or market segments. Every sales force specializes in a
definite market and helps push a product efficiently across the given
market. However, the disadvantage would arise if customers are
located over a wide geographical area.
Complex structure is used when companies are in business of selling
complex product to different customer across a large geographical
area. Here sales force structure is a combination of other structures
discussed.
Once the structure is designed companies need to make a decision
with respect to the size of the sales force. The size of the sales force is
dependent on the market size and number of customers.
The next step is to design compensation for the sales force.
Compensation plays a big motivational factor for sales people.
Companies follow a structure of a fixed amount plus a variable
amount depending of success achieved in the market. Allowances
play an important factor in the salary owing to continuous travel and
market visits.
Managing Sales Force
Integral part for success of marketing strategy is management of the
sales force. The management of sales consists of following:-
Recruitment is at the centre of an effective sales force. One approach
in the selection is asking a customer what characteristics they look for
in a sales representative. Companies develop selection procedure
where behavioral and management skills are tested.
Training is essential to remain ahead of the competition. Sales force
needs training before entering the market as well as training at
different stage of the product life cycle.
Supervision on sales force is decided on the profile of product
portfolio. A general supervision is maintained with respect to sales
people dealing with potential clients. Another supervision is related to
efficient time management from preparation of client call to closing
of the deal.
Motivation is a key aspect for management of the sales force. Here
compensation plays an important in driving up the motivational level.

Compensation can be assigned based on sales quota. Other
motivational tools are social gathering and family outing.
Evaluation is essential to management of a sales force. Sales reports
sent by the sales force serve a good starting point of evaluation.
Art of negotiation and relationship marketing these two are the
important aspects of successful sales representative and long term
benefit for the company.
Quota and territories:
In an ideal world, designing territories and distributing quotas based
on corporate targets would be simple, regardless of how many sales
reps are in your organization, or how territories shift and change as a
company grows and sales capacity increases.
However, in reality managing territories and quota is time consuming
and prone to mistakes. Companies today are often not realizing the
full potential of sales territory management, and the importance of
mapping it to Wall Street goals. Manual processes, no
standardization, and lack of analytics often hold them back from
maximizing their sales force productivity and pipeline.
There is a definite need to automate the process. Doing so will better
balance sales capacity against budget and corporate goals and reap the
rewards.
Top 3 benefits of automated sales territory and quota management:
Benefits to Sales Territory and Quota Management
Connecting sales management and finance. When the CFO sets
corporate goals for sales managers, who then distribute that goal
across their team, they often lack the ability to adjust quickly. By
automating sales territory management, sales managers can develop
multiple “what-if” scenarios and model specific scenarios to
accelerate the planning process and respond quickly to changes
throughout the year. For example, if additional reps are added to their
territory, or corporate goals are changed, they can easily adapt to stay
on target. Having one system means they’ll have historical and
current metrics that guide the territory definition and quota setting
process.
Improved processes and efficiencies. Companies that use spreadsheets
to manage quota and attainment are bound to lose money.

Spreadsheets are prone to mistakes and errors that are not easily
caught, and they don’t provide an audit trail of changes. A self-
service, workflow-based application eliminates the need to manually
distribute, receive and submit spreadsheets by email and gives reps
insight into their territories and targets.
Getting Reps Running faster. While bringing new sales reps on board
will have a positive impact on the top line in the long run, there is
always a negative impact on the bottom line because of the costs
associated with new employees. That’s why it’s critical to assign reps
a territory and quota as fast as possible – so they can start bringing in
revenue. The weeks they spend waiting to get their assignments is
money wasted. The faster new reps can be assigned accounts and the
faster quota can be distributed and adjusted, the faster that rep can
show their value.
Well-defined territories and optimized quota setting directly impact
sales results. A self-service territory and quota management solution
can help. This is why we’re excited to introduce CallidusCloud’s new
Territory and Quota Management solutions.
Evaluating performance:
Performance evaluations, which provide employers with an
opportunity to assess their employees’ contributions to the
organization, are essential to developing a powerful work team. Yet in
some practices, physicians and practice managers put performance
evaluations on the back burner, often because of the time involved
and the difficulties of critiquing employees with whom they work
closely. The benefits of performance evaluations outweigh these
challenges, though. When done as part of a performance evaluation
system that includes a standard evaluation form, standard
performance measures, guidelines for delivering feedback, and
disciplinary procedures, performance evaluations can enforce the
acceptable boundaries of performance, promote staff recognition and
effective communication and motivate individuals to do their best for
themselves and the practice.
The primary goals of a performance evaluation system are to provide
an equitable measurement of an employee’s contribution to the
workforce, produce accurate appraisal documentation to protect both

the employee and employer, and obtain a high level of quality and
quantity in the work produced. To create a performance evaluation
system in your practice, follow these five steps:
a. Develop an evaluation form.
b. Identify performance measures.
c. Set guidelines for feedback.
d. Create disciplinary and termination procedures.
e. Set an evaluation schedule.
Emerging Trends in Marketing:
Green marketing:Green marketing is the marketing of products that
are presumed to be environmentally preferable to others. Thus green
marketing incorporates a broad range of activities, including product
modification, changes to the production process, sustainable
packaging, as well as modifying advertising. Yet defining green
marketing is not a simple task where several meanings intersect and
contradict each other; an example of this will be the existence of
varying social, environmental and retail definitions attached to this
term.Other similar terms used are environmental marketing and
ecological marketing.Green, environmental and eco-marketing are
part of the new marketing approaches which do not just refocus,
adjust or enhance existing marketing thinking and practice, but seek
to challenge those approaches and provide a substantially different
perspective. In more detail green, environmental and eco-marketing
belong to the group of approaches which seek to address the lack of
fit between marketing as it is currently practiced and the ecological
and social realities of the wider marketing environment.The legal
implications of marketing claims call for caution. Misleading or
overstated claims can lead to regulatory or civil challenges. In the
United States, the Federal Trade Commission provides some guidance
on environmental marketing claims.This Commission is expected to
do an overall review of this guidance, and the legal standards it
contains, in 2011.
The green marketing mix
A model green marketing mix contains four "P's":

Product: A producer should offer ecological products which not only
must not contaminate the environment but should protect it and even
liquidate existing environmental damages.
Price: Prices for such products may be a little higher than
conventional alternatives.
Place: A distribution logistics is of crucial importance; main focus is
on ecological packaging. Marketing local and seasonal products e.g.
vegetables from regional farms is more easy to be marketed “green”
than products imported.
Promotion: A communication with the market should put stress on
environmental aspects, for example that the company possesses a CP
certificate or is ISO 14000 certified. This may be publicized to
improve a firm’s image. Furthermore, the fact that a company spends
expenditures on environmental protection should be advertised. Third,
sponsoring the natural environment is also very important. And last
but not least, ecological products will probably require special sales
promotions.
Additional social marketing "P's" that are used in this process are:
Publics: Effective Social Marketing knows its audience, and can
appeal to multiple groups of people. "Public" is the external and
internal groups involved in the program. External publics include the
target audience, secondary audiences, policymakers, and gatekeepers,
while the internal publics are those who are involved in some way
with either approval or implementation of the program.
Partnership: Most social change issues, including "green" initiatives,
are too complex for one person or group to handle. Associating with
other groups and initiatives to team up strengthens the chance of
efficacy.
Policy: Social marketing programs can do well in motivating
individual behavior change, but that is difficult to sustain unless the
environment they're in supports that change for the long run. Often,
policy change is needed, and media advocacy programs can be an
effective complement to a social marketing program.
Purse Strings: How much will this strategic effort cost? Who is
funding the effort?

The level of greening—strategic, quasi-strategic, or tactical—dictates
what activities should be undertaken by a company. Strategic
greening in one area may or may not be leveraged effectively in
others. A firm could make substantial changes in production
processes but opt not to leverage them by positioning itself as an
environmental leader. So although strategic greening is not
necessarily strategically integrated into all marketing activities, it is
nevertheless strategic in the product area.
Event marketing:
Event marketing is a promotional strategy that involves face-to-face
contact between companies and their customers at special events like
concerts, fairs, and sporting events. Brands use event marketing
entertainment (like shows, contests, or parties) to reach consumers
through direct hand-to-hand sampling or interactive displays. A
successful event marketing campaign provides value to attendees
beyond information about a product or service. A discount, free
sample, charity alignment, or fun event will make customers feel like
they are receiving a benefit and not just attending a live-action
commercial.In contrast to traditional advertising, which blasts
millions of consumers with the same general television, radio or
billboard message, event marketing targets specific individuals or
groups at gathering spots, in hopes of making quality individual
impressions.The key to pulling off an effective event marketing
campaign is to identify the target audience correctly and create an
experience that remains in participants’ memories. By finding an
opportunity to interact with the right demographic of people – both
current customers and prospective buyers – a brand can build
favorable impressions and long-lasting relationships. The best, most
creative events create interactions that not only reflect positively on
the brand at the time but generate a buzz long after the event is over.
Network marketing:
Multi-level marketing (MLM) is a marketing strategy in which the
sales force is compensated not only for sales they generate, but also
for the sales of the other salespeople that they recruit. This recruited
sales force is referred to as the participant's "downline", and can
provide multiple levels of compensation. Other terms used for MLM

include pyramid selling, network marketing, and referral marketing.
According to the US FTC, some MLM companies constitute illegal
pyramid schemes which exploit members of the organization.MLM is
one type of direct selling. Most commonly, the salespeople are
expected to sell products directly to consumers by means of
relationship referrals and word of mouth marketing. MLM
salespeople not only sell the company's products but also encourage
others to join the company as a distributor.Companies that use MLM
models for compensation have been a frequent subject of criticism
and lawsuits. Criticism has focused on their similarity to illegal
pyramid schemes, price fixing of products, high initial entry costs (for
marketing kit and first products), emphasis on recruitment of others
over actual sales, encouraging if not requiring members to purchase
and use the company's products, exploitation of personal relationships
as both sales and recruiting targets, complex and exaggerated
compensation schemes, the company and/or leading distributors
making major money off training events and materials, and cult-like
techniques which some groups use to enhance their members'
enthusiasm and devotion.
Direct marketing:
Direct marketing is a form of advertising which allows businesses and
nonprofit organizations to communicate straight to the customer
through a variety of media including cell phone text messaging,
email, websites, online adverts, database marketing, fliers, catalogue
distribution, promotional letters and targeted television, newspaper
and magazine advertisements as well as outdoor advertising. Among
practitioners it is also known as direct response.Direct marketing
focuses on the customer, data, and accountability. Hence, besides the
actual communication, a direct marketing campaign will incorporate
actionable segments and use pre- and post-campaign analytics to
measure results. Characteristics that distinguish direct marketing from
other types of marketing are:
A database of names (prospects, customers, businesses, etc.), often
with certain other relevant information such as contact
number/address, demographic information, purchase habits/history,
and company history, is used to develop a target market with common

interests, traits or characteristics. Generating such a database is often
considered part of the direct marketing campaign. Marketing
messages are addressed directly to this list of customers and/or
prospects. Addressability comes in a variety of forms including email
addresses, phone numbers, fax numbers, postal addresses, and even
web browser cookies. Direct marketing seeks to drive a specific "call
to action." For example, an advertisement may ask the prospect to call
a free phone number, mail in a response or order, or click on a link to
a website.Direct marketing emphasizes trackable, measurable
responses, results and costs from prospects and/or customers,
regardless of medium.
Direct marketing is practiced by businesses of all sizes. A direct
advertising campaign aims to deliver a good return on investment by
showing how many potential customers responded to a clear call to
action. This is in contrast to general advertising, which eschews calls
for action in favor of messages that build prospects’ emotional
awareness or engagement with a brand.
Social marketing:
Social marketing seeks to develop and integrate marketing concepts
with other approaches to influence behaviors that benefit individuals
and communities for the greater social good. It seeks to integrate
research, best practice, theory, audience and partnership insight, to
inform the delivery of competition sensitive and segmented social
change programs that are effective, efficient, equitable and
sustainable.Although "social marketing" is sometimes seen only as
using standard commercial marketing practices to achieve non-
commercial goals, this is an oversimplification. The primary aim of
social marketing is "social good", while in "commercial marketing"
the aim is primarily "financial". This does not mean that commercial
marketers can not contribute to achievement of social goals.Not all
social marketing campaigns are effective everywhere. For example,
anti-smoking campaigns such as World No Tobacco Day while being
successful (in concert with government tobacco controls) in curbing
the demand for tobacco products in North America and in parts of
Europe, have been less effective in other parts of the world such as
China, India and Russia .Social marketing applies a "customer

oriented" approach and uses the concepts and tools used by
commercial marketers in pursuit of social goals like anti-smoking
campaigns or fund raising for NGOs.Social marketers must create
competitive advantage by constantly adapting to and instigating
change. With climate change in mind, adaptations to market changes
are likely to be more successful if actions are guided by knowledge of
the forces shaping market behaviours and insights that enable the
development of sustainable competitive advantages.
Buzz marketing/viral marketing:
Buzz marketing is a viral marketing technique that is focused on
maximizing the word-of-mouth potential of a particular campaign or
product, whether that is through conversations among consumers'
family and friends or larger scale discussions on social media
platforms. By getting consumers talking about their products and
services, companies that employ buzz marketing hope to grow their
awareness through the growth of online traffic and increase sales and
profits. A buzz marketing example would be if a company decides to
promote a product through some type of event centered around a
show or stunt of some kind where consumers can try the product and
are encouraged to share their experiences through everyday
conversation or online.Online buzz marketing is typically driven by
"influencers," or early adopters of a product, that are eager to share
their thoughts on the product and proactively start conversations about
it. These people typically have established online presences and large
followings on social media platforms such as Facebook and Twitter
and possess power and influence over their follower base. Influencers'
opinions get noticed more readily and can have a positive effect on
the sales and awareness of the product. Marketers aim to rally these
influencers to build buzz for their products. Some marketers target
people known as "connectors," or big-name personalities and
celebrities who can lend instant credibility and exposure to a product.
Marketers looking for a large jump in awareness for a product will
seek out connectors, aiming for an instant jolt of societal relevance.
Social media marketing is a main component of buzz marketing.
Facebook and Twitter are two of the main social media platforms that
companies try to maintain a presence on. Using these and other,

smaller social media sites, companies can interact with customers,
receive feedback, address issues or concerns and promote their
products and services. Cultivating a rich set of shareable content and
amassing a strong following on these sites enable consumers to obtain
needed materials straight from the company and also, more
importantly, allows the company to have a real-time dialogue with
their constituents to foster an atmosphere where customers feel valued
and informed.
Consumerism:
Consumerism as a social and economic order and ideology
encourages the acquisition of goods and services in ever-increasing
amounts. Early criticisms of consumerism occur in 1899 in the works
of Thorstein Veblen. Veblen's subject of examination, the newly
emergent middle class arising at the turn of the 20th century,came to
fruition by the end of the 20th century through the process of
globalization.In the domain of politics, the term "consumerism" has
also been used to refer to something quite different called the
consumerists' movement, consumer protection or consumer activism,
which seeks to protect and inform consumers by requiring such
practices as honest packaging and advertising, product guarantees,
and improved safety standards. In this sense it is a political
movement, or a set of policies aimed at regulating the products,
services, methods, and standards of manufacturers, sellers, and
advertisers in the interests of the consumer.In the domain of
economics, "consumerism" refers to economic policies placing
emphasis on consumption. In an abstract sense, it is the consideration
that the free choice of consumers should strongly orient the choice by
manufacturers of what is produced and how, and therefore orient the
economic organization of a society .In this sense, consumerism
expresses the idea not of "one man, one voice", but of "one dollar, one
voice", which may or may not reflect the contribution of people to
society.
Customer relationship management:
Customer relationship management (CRM) is an approach to
managing a company’s interaction with current and future customers.
The CRM approach tries to analyse data about customers' history with

a company, in order to better improve business relationships with
customers, specifically focusing on retaining customers, in order to
drive sales growth. One important aspect of the CRM approach is the
systems of CRM that compile information from a range of different
channels, including a company’s website, telephone, email, live chat,
marketing materials, social media, and more. Through the CRM
approach and the systems used to facilitate CRM, businesses learn
more about their target audiences and how to best cater to their needs.
However, the adoption of the CRM approach may also occasionally
lead to favouritism within an audience of consumers, leading to
dissatisfaction among customers and defeating the purpose of CRM.
Global marketing:
Global marketing is “marketing on a worldwide scale reconciling or
taking commercial advantage of global operational differences,
similarities and opportunities in order to meet global objectives".One
of the product categories in which global competition has been easy to
track in U.S.is automotive sales. The increasing intensity of
competition in global markets is a challenge facing companies at all
stages of involvement in international markets. As markets open up,
and become more integrated, the pace of change accelerates,
technology shrinks distances between markets and reduces the scale
advantages of large firms, new sources of competition emerge, and
competitive pressures mount at all levels of the organization. Also,
the threat of competition from companies in countries such as India,
China, Malaysia, and Brazil is on the rise, as their own domestic
markets are opening up to foreign competition, stimulating greater
awareness of international market opportunities and of the need to be
internationally competitive. Companies which previously focused on
protected domestic markets are entering into markets in other
countries, creating new sources of competition, often targeted to
price-sensitive market segments. Not only is competition intensifying
for all firms regardless of their degree of global market involvement,
but the basis for competition is changing. Competition continues to be
market-based and ultimately relies on delivering superior value to
consumers. However, success in global markets depends on
knowledge accumulation and deployment. Today, more and more

marketing companies specialize in translating products from one
country to another country.
Evolution to global marketing
Global marketing is not a revolutionary shift, it is an evolutionary
process. While the following does not apply to all companies, it does
apply to most companies that begin as domestic-only companies.
International marketing has intensified and is evident for
approximately nearly all aspects of consumer’s daily life. Local
regions or national boundaries no longer restricted to the competitive
forces. To be successful in today's globalized economy, it is a must
for the companies to simultaneously be responsive to local as well as
global market conditions and varying aspect’s related to the
international marketing process. Hence, international marketing skills
are an important ingredient for every company, whether or not it is
currently involved in exporting the activities for the endorsement of
the brand or the company. The internationalized marketplace has been
transformed very quickly in recent years by shifts in trading
techniques, standards and practices. These changes have been
reinforced and retained by new technologies and evolving the
economic relationships between the companies and the organizations
which are working for the trade across the globe. This assignment
project work is just an attempt to get integrate these developments and
attempts in the field of the market journalism into the burgeoning
literature on international marketing process as well as on recent
research findings on the International marketing. The research
emphasis within the subject has evolved alongside changes in the
stress given to key aspects of international trade market. The pre-
occupation of early researchers with exports and selling is being
replaced by a more balanced view which gives increasing weight to
other aspects of international marketing such as licensing, joint
ventures, and overseas subsidiaries. In effect, the traditional
ethnocentric conceptual view of international marketing trade is being
counterbalanced by a more accurate global view of markets. This
process of change is tracked in this paper and the growing importance
of a strategic and organizational approach to international marketing
is emphasized in this article theory. Focused attention is paid to the

heterogeneous nature of international marketing process. The
diversity of the globalized situations is matched by the variety of
enterprises which play a vital part in the marketing exploration
process. There is also explanation focuses on the matching of the
available company resources and marketing goals in successful
international marketing trade. The concept which unveils the paper
brings out the importance of effective marketing procedures to
success in international markets and trade over the international.
Rural marketing:Rural marketing can be defined in terms of the
location (villages) and occupation (mainly farming). A large variety
of transactions are considered a part of rural marketing. These are
marketing of:
Agricultural inputs like fertilizers. Pesticides, farm equipment.
Products made in urban centres and sold to rural areas like soaps,
toothpastes, TVs etc.
Products made in rural areas sold to urban centres like khadi cloth,
handcrafted products etc.
Products made and sold in rural areas like milk and milk products.
Locally manufactured toothpowder, cloth etc.
Some simple facts to support this: In 2010, LIC sold 55% of its
policies to rural areas; of over two billion BSNL mobile connections
50% are in small towns or villages; 41 million Kisan Credit cards
have been issued as against 22 million credit cum debit cards in urban
areas. With the growing market and the growing purchasing power it
is therefore natural that rural markets form an important part of the
total market of India.
There is an immense opportunity for the marketer to create innovative
and creative solutions to tap the rural potential. As per CK Prahalad
‘Improving the lives of billions at the bottom of economic pyramid is
a noble endeavour. It can also be a lucrative one.’
E-Commerce: Marketing in The Digital Age.
E-commerce marketing is the practice of guiding online shoppers to
an e-commerce website and persuading them to buy the products or
services online. E-commerce marketing can include practices like:
Search engine optimization to help a website to rank higher in organic
search engine listings, affiliation with better-known websites through

referral marketing or banner advertising and retention of current
customers through email marketing
While there are many similarities between marketing an e-commerce
website and marketing a brick and mortar store, e-commerce
marketing involves some unique challenges and opportunities (See
also Brick-and-Mortor Marketing). Online, consumers don’t feel
invested in a shopping venture the way they would if they’d gotten in
their car to visit a physical location, because visiting an e-commerce
website requires no more effort than a mouse click.Additionally, e-
commerce businesses don’t have opportunities to draw customers in
with the physical enticements of a well-run store – there is no soft
music, relaxing smell or helpful, well-dressed salesperson to help
them make their choice.On the flipside, however, shopping online is
faster, easier and more private, which makes it very appealing to tech-
savvy consumers. With a fully-functioning, easy-to-use website and
effective customer engagement tools, an e-commerce website can
make shoppers want to complete their transactions online. This is
financially beneficial, as e-commerce businesses require much less
overhead to run successfully.Still, many e-commerce marketing
companies use this lack of investment in online shopping to justify
high spending on increasing traffic to the website. Often, if a
marketing firm puts thought into their e-commerce marketing
strategy, this high spending may not be necessary.
Who employs E-commerce Marketing?
All manner of retailers – including clothing stores, fabric wholesalers,
furniture manufacturers and technology companies employ e-
commerce marketing. Sometimes, brick and mortar retailers make
conscious decisions not to build e-commerce websites, because they
want the experience of visiting their store to be a unique, elite
experience. These retailers are often not interested in expanding their
businesses or selling for a competitive price.However, any other
business that is interested in increasing their sales should not only
build an e-commerce website but put thought and effort into
marketing it effectively. For example, Door-to-Door Organics is a
business that partners with local farmers to deliver fresh, organic
produce to customers’ doorsteps. While fresh produce is not the first

product that comes to mind for an e-commerce website, the usability
and intuitive functionality of the website contributes to Door-to-door
Organics’ success (See also Marketing Organic Products).
A Famous E-Commerce Marketing Campaign:
Amazon.com began in 1994 as an online bookstore. While this is how
they are still best-known, the e-commerce website now sells
everything from clothes, to vitamins/ to MP3s, to previously-owned
electronics. Sales are made through their own suppliers, third-party
vendors, and private individuals. Amazon’s reign continues because
they continue to push technological boundaries (their proprietary e-
reader Kindle has taken the nation by storm) and because their e-
commerce platform is functional, easy-to-use, and secure.
What kinds of customers are effectively marketed to with E-
commerce Marketing?
Young, Internet-savvy consumers are the most likely to be affected by
an e-commerce marketing campaign (See also Youth Marketing).
Older consumers who are not as familiar with the Internet are less
likely to make their purchases online in the first place. But when they
do, they are also less particular about the quality of the e-commerce
website.
E-commerce Marketing Priorities
Entice visitors to your e-commerce website through:
Search engine optimization
Pay-per-click campaigns
Public relations – news releases, articles and stories
Online advertising
Convert visitors into customers through:
In-site promotions
Product discounts
Customer recommendations
Opt-in email promotions
Website usability
Encourage repeat customers through:
Quality products
Competitive pricing
Building relationships

Increasing per-customer purchases
After-sale marketing and relationship building
One thing that is universally important to e-commerce consumers is
security. Because buying online necessitates the transfer of personal
information including a credit card number and personal shipping
address, it is extremely important to ensure that your e-commerce
website takes great care with customer information. Nothing can
damage an e-commerce marketing campaign and a reputation faster
than a slew of stolen identities or other financial security breaches.
How is an E-commerce Marketing plan developed and employed?
An e-commerce marketing plan is developed by focusing on three
objectives: helping new visitors to find the website, turning visitors
into customers, and enhancing your website’s usability and after-sale
marketing to encourage repeat visitors.Enticing visitors and
converting visitors work hand in hand. One without the other
dramatically reduces the opportunities for creating new customers. A
website needs to entice new visitors to visit and then provide
sufficient incentive to turn those visitors into a buying
customers.Helping new visitors find a company’s e-commerce
website is largely dependent on search engine positioning and banner
advertising. A successful e-commerce marketing team needs to have
expertise in search engine optimization, pay-per-click marketing,
social media marketing, and display advertising to reach the top of
search results.Search engine optimization, better known as SEO, is
one of the most critical parts of e-commerce marketing. It is based on
special algorithms that analyze the instances of specific keywords on
your website. Because users navigate the Internet through search
engines like Google, these results play a large role in the success of
your website. A good SEO campaign can position your e-commerce
website to rise to the top of the Google rankings. For example,
Googling “pretty yarn” brings up Dragon Tale Yarns sold by the e-
commerce branch of Earth Guild, a store based in North Carolina, as
the fourth result. Earth Guild is not a large, well-known craft store,
nor does it have a particularly appealing web presence. What it does
have is excellent SEO – because it shows up so quickly in the search
results, it likely experiences much more traffic than its

competitors.Pay-per-click advertising operates similarly to SEO since
it is based on keywords. However, whereas search engine
optimization works organically (meaning that a marketing firm
doesn’t have to pay for it), PPC results are the results that show up in
yellow boxes on Google. Marketing campaigns pay to be represented
by specific keywords, and owe money each time a user clicks on one
of these ‘sponsored’ links. PPC and SEO campaigns often work very
well together, by covering a variety of organic and paid keywords.
Social media marketing can be very important to e-commerce
websites. By creating an effective Facebook business page and
enticing potential customers to ‘like’ your page with exclusive offers
and discounts, you will not only gain immeasurable word-of-mouth
advertising through the network, but will establish yourself as a
trustworthy, reputable Internet business.
Display advertising can be intimidating to smaller Internet retailers,
but it has been found to be very worthwhile. By buying small banner
ads on related blogs, message boards and other websites, you can
showcase your business in front of people who wouldn’t have found it
otherwise.
Effective, strategic marketing is sometimes enough to attract visitors
to a website, but the work doesn’t end there. Next, an e-commerce
marketing campaign will convince them to purchase the available
product or service. Website visitors become customers because of
their experience on your website. While the quality and pricing of the
product is important, the user experience is just as important. The
domain name should be easy to spell, it should load quickly, and it
should look good and be easy to read.
On the product pages, it is essential that all offerings are easy to find,
easy to understand, and are accompanied by extensive details and
photos. Online shoppers are drawn to purchase if they know right
away how much your product and shipping costs, if they can see
multiple views of a product, zoom in on your photos, read reviews
from other customers, and save products they’re considering in a
shopping cart. All of these actions mirror the way they shop in a brick
and mortar location.

Repeat customers are earned through customer service. Year after
year, Zappos.com, an online retailer that specializes in shoes, ranks
very highly as a place that customers would recommend to friends
and use the next time they need to purchase shoes. The reason for this
is excellent customer service. Zappos offers free shipping both ways,
no-questions-asked returns and exchanges for a full year, video
descriptions, and comprehensive reviews of almost every product.
Additionally, they employ a staff of customer service representatives
who handle every interaction with a light-hearted expertise.
Top 10 Internet Retailers
Amazon.com Inc.
Staples Inc.
Apple Inc.
Walmart.com
Dell Inc.
Office Depot Inc.
Liberty Interactive Corp.
Sears Holdings Corp.
Netflix Inc.
CDW Corp.

Unit 4
Bottom of Pyramid Marketing:
“Bottom of the Pyramid” (BoP) was first used by U.S. President
Franklin D. Roosevelt in 1932 while he was talking about « the
forgotten man at the bottom of the economic pyramid ». In
economics, the bottom of the pyramid is the 2.5 billion people who
live on less than $2.50 per day. The phrase “Bottom of the Pyramid”
is used in particular by people developing new models of doing
business that deliberately target the poorest regions. From
multinational companies’ perspective (MNC), there is a growing
interest in the potential market of developing countries on the small
upper-middle-class segments.But corruption, illiteracy, currency
fluctuations, inappropriate infrastructures and so on make MNCs
skeptical about their business profitably. These factors and also the
outdated representation of the poor hide the real potential of BoP
markets.Bottom of Pyramid constitutes the market made of country’s
poorest people. In India approximately 6 Lacs villages and 72% of
country’s population constitutes BOP. The great majority of men and
women of this BOP cluster work in agriculture, animal husbandry,
factories or own rural shops and their income levels less than Rs.1.5
Lacs/year. Most companies have not traditionally considered people
at bottom of pyramid as potential customers due to their low level of
their individual incomes. It is a common belief that poor do not have
any significant purchasing power and therefore do not represent an
attractive market. However, this assumption ignores the volume of the
market and thus there are tremendous benefits for companies if they
choose to serve the highly underserved and less comparatively
markets at BOP. Over the past few years, business leaders and
strategists around the world have increasingly been focusing their
attention on the challenges of intense competition and slowing growth
in high income markets. This has led many of them to reconsider the
potential of emerging and low-income markets. Rising purchasing
power, changing consumption patterns, increased access to
information and communication technology, improving infrastructure
and government initiatives to boost the main constituent of Indian
BOP market.

Understanding the BOP consumers
Harvard Business School’s Professor V.K. Rangank and Professor
Michael Chu divide the BOP into the same 3 sub-levels but propose
two different BOP strategies. Their criteria for categorizing income
levels are different, but their ideas on strategy are the same.
1. Low income ($3-5/PPP)
2. Subsistence ($1-3/PPP)
3. Extreme poverty (<$1/PPP)
Revolutionizing Business Models by Cultivating and Using
“Purchasing Power”
However, the expenditures of individuals in the BOP are small:
consumers are all micro-consumers, and they are scattered from the
outskirts of cities to farming areas. Therefore, the issues to be
considered are how to deal with micro-consumers and how to
concentrate a scattered market or lower the cost of accessing the
market.The following business model was proposed:
1. Devise a way to micronize normal goods and services (e.g. smaller
packaging, instalment payment plans), or a way to normalize micro-
consumers (e.g. group purchasing).
2. Train buyers to become sellers and/or systematize (formalize).
3. Use ICT to connect the scattered BOP market, realize merit of
scale. An oft-heard example of the micronization of normal goods and
services is Unilever’s move to smaller packaging of consumer
products and microfinancing, but there are good examples in other
fields as well. For example, Airtel, the largest mobile communication
services company in India, reduced their call-time billing units from
minutes to seconds, thus increasing demand from the BOP. Further,
an example of normalizing the unstable, micro-purchasing power of
BOP consumers can be seen in the BOP-targeted loan business of
India’s ICIC Bank. Their business model is to lend money to a Self-
Help Group composed of 10-20 people and have them all take
collective responsibility for repaying the loan, rather than providing
microfinancing to each individual consumer.
Bottom of the pyramid, as the largest but poorest socio-economic
group in the world, has attracted numerous multinational companies
to serve. While a couple of MNCs might have succeeded making

profits, many of them found no luck in the venture. The high
penetration rate requirement is one among numerous hurdles in this
market, which caused early adopters of the BOP concept left as they
encountered more risks than profits. Some would direct their efforts
as part of CSR practices, rather than profit making business. The
diminishing interest in serving the BOP market has encouraged
academics and practitioners to study the issues.
Design-Develop-Distribute approach towards BoP: Companies are
modifying their marketing mix to suit the expectancy and pockets of
the bottom of the pyramid consumers.
Product: Companies are striving to leverage technological
advancement and innovation. They have come up with products
which are capable of meeting the untapped demands of the bottom of
the pyramid consumers with an affordable price. Coca-Cola came up
with “Chota Coke” to make soft drink affordable. Micromax and
Spice have captured the bottom of the pyramid market with low-
priced but high featured mobile handsets.
Price: We know that the bottom of the pyramid is a price sensitive
segment. It’s difficult to offer smaller packaging at lower prices due
to the additional cost. Many fast-moving consumer goods are being
sold in smaller quantities at low prices to reach out to the consumers
of this segment. However, some companies went beyond it. Nirma,
from being a local player emerged as a major detergent brand
preferred by this segment. It adopted backward integration and
produced its raw material as well. It also used simple and cheaper
packaging material. Likewise, Chic shampoo sachets were available
at 50p initially and now at Re. 1. This pioneered the sachet packaging
fiasco. Hindustan Unilever Ltd. (HUL) followed the bill with its fast-
moving consumer goods like Surf, Fair n Lovely etc.
Place: Urban bottom of the pyramid consumers have access to retail
outlets. But in rural areas companies like HUL have come up with
concepts like using self-help groups to distribute and market its
products. ITC launched e-chaupal and attempted to capture the rural
bottom of the pyramid segment.
Promotion: The consumers of this segment are not native English
speakers, or they hardly know the language. Companies promote their

products in regional dialects to make it easier for the local people. In
southern Indian states, advertisements are made in regional languages
with local movie stars as endorsers so that people can relate with them
easily.
India is a big market for the bottom of the pyramid segment. Local
and multinational companies cannot afford to ignore it. More and
more companies are coming up with unique marketing ideas and
product offerings to target the bottom of the pyramid consumers. This
gave many companies opportunities to leverage through recessionary
times with ease.
Twelve Principles of Innovation for BOP Markets
1. Focus on price performance of products and services. Serving BOP
markets is not just about lower prices. It is about creating a newprice–
performance envelope. Quantum jumps in price performanceare
required to cater to BOP markets.
2. Innovation requires hybrid solutions. BOP consumer problems
cannot be solved with old technologies. Most scalable,
priceperformance- enhancing solutions need advanced and emerging
technologies that are creatively blended with the existing and rapidly
evolving infrastructures.
3. As BOP markets are large, solutions that are developed must be
scalable and transportable across countries, cultures, and languages.
How does one take a solution from the southern part of India to the
northern part? From Brazil to India or China? Solutions must be
designed for ease of adaptation in similar BOP markets. This is a key
consideration for gaining scale.
4. The developed markets are accustomed to resource wastage. For
example, if the BOP consumers started using as much packaging per
capita as the typical American or Japanese consumer, the world could
not sustain that level of resource use. All innovations must
focus on conserving resources: eliminate, reduce, and recycle.
Reducing resource intensity must be a critical principle in product
development, be it for detergents or ice cream.
5. Product development must start from a deep understanding of
functionality, not just form. Marginal changes to products
developedfor rich customers in the United States, Europe, or Japan

will not do.The infrastructure BOP consumers have to live and work
in demands
a rethinking of the functionality anew. Washing clothes in anoutdoor
moving stream is different from washing clothes in thecontrolled
conditions of a washing machine that adjusts itself to thelevel of dirt
and for batches of colored and white clothes.
6. Process innovations are just as critical in BOP markets as
productinnovations. In developed markets, the logistics system for
accessingpotential consumers, selling to them, and servicing products
is welldeveloped.A reliable infrastructure exists and only minor
changesmight have to be made for specific products. In BOP markets,
thepresence of a logistics infrastructure cannot be assumed.
Often,innovation must focus on building a logistics
infrastructure,including manufacturing that is sensitive to the
prevailingconditions. Accessing potential consumers and educating
them canalso be a daunting task to the uninitiated.
7. Deskilling work is critical. Most BOP markets are poor in
skills.The design of products and services must take into account the
skilllevels, poor infrastructure, and difficulty of access for service
inremote areas.
8. Education of customers on product usage is key. Innovations
ineducating a semiliterate group on the use of new products can
poseinteresting challenges. Further, most of the BOP also live in
“mediadark” zones, meaning they do not have access to radio or TV.
In theabsence of traditional approaches to education—
traditionaladvertising—new and creative approaches, such as video
mountedon trucks and traveling low-cost theatrical productions whose
job itis to demonstrate product usage in villages, must be developed.
9. Products must work in hostile environments. It is not just
noise,dust, unsanitary conditions, and abuse that products must
endure.Products must also be developed to accommodate the low
quality ofthe infrastructure, such as electricity (e.g., wide fluctuations
involtage, blackouts, and brownouts) and water (e.g.,
particulate,bacterial, and viral pollution).
10. Research on interfaces is critical given the nature of the
consumerpopulation. The heterogeneity of the consumer base in terms

oflanguage, culture, skill level, and prior familiarity with the
functionor feature is a challenge to the innovation team.
11. Innovations must reach the consumer. Both the highly
dispersedrural market and a highly dense urban market at the BOP
representan opportunity to innovate in methods of distribution.
Designingmethods for accessing the poor at low cost is critical.
12. Paradoxically, the feature and function evolution in BOP
marketscan be very rapid. Product developers must focus on the
broadarchitecture of the system—the platform—so that new features
canbe easily incorporated. BOP markets allow (and force) us
tochallenge existing paradigms. For example, challenging the
gridbasedsupply of electricity as the only available source for
providinggood-quality, inexpensive energy is possible and necessary
in theisolated, poor BOP markets.
It might appear that the new philosophy of innovation for the
BOPmarkets requires too many changes to the existing approach
toinnovation for developed markets. It does require significant
adaptation,but all elements of innovation for the BOP described here
might not
apply to all businesses. Managers need to pick and choose and
prioritize.
Few challenges-The institutional context of BoP markets
The most interesting and, at the same time, the most disturbing
aspectof the BOP market is that the problems are known; so are the
solutions. Often,the missing link is the need for investments in the
education of customers,technology to develop that solution into an
affordable product, and thedistribution channels to make it widely
available. Because BOP markets areoften under the radar screen of
large firms, these opportunities do not attract thenecessary technical
or market development investments.Iodine Deficiency Disorder (IDD)
affects more than 200 million children indeveloping countries, of
which over 70 million live in India. IDD is one of theprincipal reasons
for mental retardation and disabilities such as goiter. It iswell-known
that iodine in common salt is the easiest way to get the requireddaily
dose. It is also well-known that only 20 percent of the salt in India
isiodized, and even iodized salt loses its iodine content during the

harshconditions of storage, transportation, and Indian cooking. The
solution that isneeded is clear: Get enough iodine in salt so that
children will get an adequatedose with their food in spite of the losses
in storage and cooking. However, itmust be affordable, meaning that
the price cannot be much over the regular,untreated salt that is easily
available and currently consumed by the BOPconsumers.The
technical, distribution, and education effort required can be
difficult.The Annapurna Salt story from Hindustan Lever Ltd. (HLL)
illustrates theprocess by which a large firm with a global reach can
create the connectionbetween a known problem and a known solution.
HLL had to investigate whyiodine dissipated from iodized salt and
invent an advanced technology solutioncalled microencapsulation to
retain iodine. Because of microencapsulation, HLLcan guarantee that
the iodine will not be dissipated during storage or cooking but will be
released only after the food is ingested. HLL called this
K15(Potassium, 15 parts per million). However, technology is only
one part of thesolution. HLL had to educate BOP consumers on why
K15 was better thanregular salt as well as iodized salt in which iodine
is not encapsulated. HLL tookmultiple approaches to education. The
company used regular information-orientedadvertisements on national
TV. More important, to reach the villageswhere TV coverage is
limited, it created a direct education and distributioneffort involving
local village women. Selected village leaders were appointedShakti
Ammas (empowered women) who acted as educators of the local
villageon nutrition as well as distributors of the product. These
women distributed allHLL products, not just salt. As a result, HLL
found an innovative way toeducate the rural BOP consumers and gain
access to a new distribution system.
Marketing Research in BoP Markets: Many companies entered into
BOP Markets to cater the need of BOP customers.e.g. ICICI Bank.
Innovations in Finance:The number of people living on less than $1
per day in India is significantly greater than the entire population of
the United States. From a social perspective, this is a humanitarian
pandemic. From an economic perspective, these people represent the
bottom of the pyramid (BOP). From a commercial perspective, these
individuals are not considered a viable market given their miniscule

purchasing power. Do the poor of India represent an opportunity for a
large, organized financial services company?
Case Study:
Can lending to the very poor be financially viable for banks? Should
leadership training precede access to saving and credit offered by the
organized financial sector? Are there alternate models of credit
evaluation, contract enforcement, and building trust in large
institutions among the poor consumers? The ICICI experience
provides insights on how formal banking can convert the poor into
customers, at the same time empowering the poor. ICICI Bank, the
second-largest banking institution in India, sees the poor as a lucrative
customer class critical to the future of the company. “I think we have
to recognize a whole lot of potential is going to come out of the
Bottom of the Pyramid,”1 stated Chanda Kochhar, the Executive
Director of Retail Banking for ICICI Bank. ICICI deems the nearly
400 million impoverished people of
India as a huge market with real economic potential and commercial
viability. In fact, the mission statement of the Social Initiatives Group
within ICICI Bank is “to identify and support initiatives designed to
improve the capacities of the poorest of the poor to participate in the
larger economy.” Also, there is awidespread belief within ICICI “that
the poor do pay for the services rendered to them and they ought to be
viewed as consumers rather than passive beneficiaries. “With this idea
engrained as a core belief, ICICI Bank has focused its resources and
creative thinking toward innovatively serving the bottom ofthe
economic pyramid.
Concept of Informal Economy: System of trade or economic
exchange used outside state controlled or money-based transactions.
Practiced by most of the world's population, it includes barter of
goods and services, mutual self-help, odd jobs, street trading, and
other such direct sale activities. Income generated by the informal
economy is usually not recorded for taxation purposes and is often
unavailable for inclusion in gross domestic product (GDP)
computations.
ETHICAL CONCERNS: social responsibility must be incorporated
into bottom-of-the-pyramid strategies. There are two over-riding

questions to keep in mind in this exploration of specific ethical
concerns. Is thefundamental relationship between buyers and sellers
cooperative or is it adversarial? And to what extentmust global
corporations adjust their tactics and strategies, perfected in developed
economies, to thespecial circumstances and conditions of developing
countries?
Products: All products are not created equal in ethical terms,
especially when they are marketed to the BOP. E.g.Procter &
Gamble’s pursuit of growth and revenue by selling detergent in
single-serve packages tolow-income women. The utility of this
product raises no ethical concerns. But what if P& G wereto choose
another of its diverse product categories, say Cover Girl cosmetics?
amounts are spent by the poor on these products must necessarily
reduce the funds available for essentialgoods: adequate food, clothing,
and shelter.
Pricing: The buyer can and often does refuse to buy a product if he or
she finds it costly. Packaging It is now commonly understood that the
BOP, with such limited resources, cannot afford to have an
“inventory” of anything; they buy only what they need to use or
consume immediately and then buy more when they need more. Thus,
many of the success stories we have from Procter & Gamble or
Unilever are based on packaging the goods in single-serve quantities,
often referred to as sachets.
Advertising t: This also increase the product cost.

Branding: This poses an ethical issue for consumer goods producers.
Brands become widely recognized andpreferred only through the
expensive process of advertising and other forms of promotion, and
this expense,of course, is passed along to the consumer in the higher
price of the item. We also know that branded itemsare often identical,
in functional terms, to their unbranded, generic counterparts. Then the
critical questionis: does the brand impart real value to its buyer? In
developed countries and economies, we assureourselves that the
psychological value imparted by the brand name justifies the higher
price, even if there is no additional functional value. This explanation
is less persuasive when applied to the BOP.

Ethical marketing relies on a long-term strategy of continuing
education, campaigning, and activism. It’s about helping consumers
make better, more conscious choices about the products they buy and
the stores they frequent. It’s about changing the way we think about
how goods are provided, the people who make and sell the things we
buy every day, and the communities that rely on fair, ethical trade to
survive. It’s about cultivating brand loyalty by aligning your
organizational values with those of your ideal customers.

MBA 2018
SUBJECT NAME:
HUMAN RESOURCE MANAGEMENT

MBA204-18 HUMAN RESOURCE MANAGEMENT
Unit I
Human Resource Management (HRM): Nature, Scope, Objectives and functions
of HRM. Evolution of HRM, HR as a factor of competitive
advantage.Organization of HR department, Line ad staff responsibility of HR
managers, competencies of HR Manager.Personnel Policies and Principles.
Strategic HRM: Introduction, Integrating HR strategy with Business Strategy,
Difference between SHRM and HRM. HRM Environment and Environment
Scanning. Human Resource Planning: Meaning, Process and importance,
factors affecting Human Resource Planning. Job Analysis: Process, methods of
Job Description & Job Specification.
Unit 2
Recruitment & Selection: Meaning & Concept, Process & Methods Recruitment
& Selection, Induction & Placement. Training & Development: Meaning &
Concept of Training & Development, Methods of Training & Development,
Evaluating training effectiveness. HRM vs. HRD. Career Planning &
Development: concept of career, career planning, career development, process
of career planning and development, factors affecting career choices,
responsibilities of Employers / managers, organization and employees in career
planning and development, career counseling. Internal Mobility: Promotion,
Transfer, Demotion, Separation, downsizing and outplacement.
Unit 3
Performance Appraisal: Meaning & Concept of Performance Appraisal,
Methods & Process of Performance Appraisal, Issues in Performance Appraisal,
Potential Appraisal. Compensation Management- Concept and elements of
compensation, Job evaluation, Wage / Salary fixation, Incentives Plans &
Fringe Benefits. Quality of work life (QWL): Meaning, Concept, Techniques to
improve QWL. Health, Safety & Employee Welfare, Social Security. Quality
Circles: Concept, Structure, Role of Management, QCs in India.
Unit 4
Industrial Relations: Government’s concerns, Union’s concerns, Management
concerns; Approaches of IR; Dispute Resolution Machinery. Collective
Bargaining: Meaning, Scope, Objectives, Issues and Strategies, steps of
collective bargaining, negotiation skills. Participative Management, Grievance
Handling, Disciplining and Counseling of employees, HRIS, HR Audit.Ethical
Issues in HRM. Human Resource Management practices in India.

UNIT-1
Introduction to Human Resource Management
Every business unit needs human resource (manpower) for the
conduct of different business activities. In fact, no organisation can
exist or operate efficiently without the support of human resource.
Such human resource includes top level managers, executives,
supervisors and other subordinate / lower level staff / employees. A
business organisation has to estimate its future manpower needs and
adjust its manpower planning and development programmes
accordingly. This is called 'staffing' function of management. Human
resource management is also described as personnel management or
manpower management.
According to Edwin Flippo, "Personnel Management is the planning,
organising, directing and controlling of the procurement,
development, compensation, integration and maintenance of people
for the purpose of contributing to organizational, individual and social
goals".
Various areas such as recruitment and selection, wage payment and
industrial relations are covered under human resource management.
Meaning of Human Resource
In an industrial unit, large number of persons are employed in order to
conduct various operations and activities. This is treated as human
resource or manpower employed. A business unit needs material
resources as well as human resource for the conduct of various
activities. Of all the "M"s in management (such as Materials,
Machines, Methods and Money) the most important "M" stands for
Men i.e., manpower working in the organisation. It is through
manpower/employees that all other ingredients of an enterprise-
money, machines, materials, marketing, etc., are managed. In brief,
Human Resource (HR) constitutes the most important and the most
productive resource of an industrial / business unit.
It is rightly said that "machines are important in the production
process but the man behind the machines is more important". He
transforms the lifeless factors of production into useful products.
Human resource (HR) is an important asset of a business unit. Well-
trained, loyal and efficient team of workers brings success and

stability to a business unit. This suggests the importance of human
resource in business. People and the organisation in which they work
are inter-related and interdependent. organisation moves towards
prosperity only by using its available human resource purposefully.
Similarly, employees get various monetary and other benefits through
the prosperity of their organisation.
DEFINITION
According to Flippo “Personnel management, or say, human resource
management is the planning, organising, directing and controlling of
the procurement development compensation integration, 4intenance,
and separation of human resources to the end that individual,
organisational and social objectives are accomplished”.
The National Institute of Personnel Management (NIPM) of India has
defined human resource/personnel management as “that part of
management which is concerned with people at work and with their
relationship within an enterprise. Its aim is to bring together and
develop into an effective organisation of the men and women who
make up an enterprise and having regard for the well-being of the
individuals and of working groups, to enable them to make their best
contribution to its success”.
According to Decenzo and Robbins “HRM is concerned with the
people dimension in management. Since every organisation is made
up of people, acquiring their services, developing their skills,
motivating them to higher levels of performance and ensuring that
they continue to maintain their commitment to the organisation are
essential to achieving organisational objectives. This is true,
regardless of the type of organisation-government, business,
education, health, recreation, or social action”.
Objectives:
The primary objective of HRM is to ensure the availability of right
people for right jobs so as the organisational goals are achieved
effectively.
1. To help the organisation to attain its goals effectively and
efficiently by providing competent and motivated employees.
2. To utilize the available human resources effectively.

3. To increase to the fullest the employee’s job satisfaction and self-
actualisation.
4. To develop and maintain the quality of work life (QWL) which
makes employment in the organisation a desirable personal and social
situation.
5. To help maintain ethical policies and behaviour inside and outside
the organisation.
6. To establish and maintain cordial relations between employees and
management.
7. To reconcile individual/group goals with organisational goals.
SCOPE AND FUNCTIONS OF HRM
1.The Labour or Personnel Aspect:This is concerned with
manpower planning, recruitment, selection, placement, transfer,
promotion, training and development, lay-off and retrenchment,
remuneration, incentives, productivity, etc.
2. Welfare Aspect:It deals with working conditions, and amenities
such as canteen, creches, rest and lunch rooms, housing, transport,
medical assistance, education, health and safety, recreation facilities,
etc.
3. Industrial Relations Aspects:This covers union-management
relations, joint consultation, collective bargaining, grievance and
disciplinary actions, settlement of disputes, etc.
Functions:
We have already defined HRM. The definition of HRM is based on
what managers do. The functions performed by managers are
common to all organizations. For the convenience of study, the
function performed by the resource management can broadly be
classified into two categories, viz.
(1) Managerial functions, and
(2) Operative functions (see fig. 1.2).
These are discussed in turn.
(1) Managerial Functions:
Planning:
Planning is a predetermined course of actions. It is a process of
determining the organisational goals and formulation of policies and
programmes for achieving them. Thus planning is future oriented

concerned with clearly charting out the desired direction of business
activities in future. Forecasting is one of the important elements in the
planning process. Other functions of managers depend on planning
function.
Organising:
Organising is a process by which the structure and allocation of jobs
are determined. Thus organising involves giving each subordinate a
specific task establishing departments, delegating authority to
subordinates, establishing channels of authority and communication,
coordinating the work of subordinates, and so on.
Staffing:
TOs is a process by which managers select, train, promote and retire
their subordinates This involves deciding what type of people should
be hired, recruiting prospective employees, selecting employees,
setting performance standard, compensating employees, evaluating
performance, counseling employees, training and developing
employees.
Directing/Leading:
Directing is the process of activating group efforts to achieve the
desired goals. It includes activities like getting subordinates to get the
job done, maintaining morale motivating subordinates etc. for
achieving the goals of the organisation.
Controlling:
It is the process of setting standards for performance, checking to see
how actual performance compares with these set standards, and taking
corrective actions as needed.
(2) Operative Functions:
The operative, also called, service functions are those which are
relevant to specific department. These functions vary from department
to department depending on the nature of the department Viewed
from this standpoint, the operative functions of HRM relate to
ensuring right people for right jobs at right times. These functions
include procurement, development, compensation, and maintenance
functions of HRM.
A brief description of these follows:
Procurement:
It involves procuring the right kind of people in appropriate number to
be placed in the organisation. It consists of activities such as
manpower planning, recruitment, selection placement and induction
or orientation of new employees.
Development:
This function involves activities meant to improve the knowledge,
skills aptitudes and values of employees so as to enable them to
perform their jobs in a better manner in future. These functions may
comprise training to employees, executive training to develop
managers, organisation development to strike a better fit between
organisational climate/culture and employees.
Compensation:
Compensation function involves determination of wages and salaries
matching with contribution made by employees to organisational
goals. In other words, this function ensures equitable and fair
remuneration for employees in the organisation. It consists of
activities such as job evaluation, wage and salary administration,
bonus, incentives, etc.
Maintenance:
It is concerned with protecting and promoting employees while at
work. For this purpose virus benefits such as housing, medical,
educational, transport facilities, etc. are provided to the employees.

Several social security measures such as provident fund, pension,
gratuity, group insurance, etc. are also arranged.
It is important to note that the managerial and operative functions of
HRM are performed in conjunction with each other in an
organisation, be large or small organisations. Having discussed the
scope and functions of HRM, now it seems pertinent to delineate the
HRM scenario in India.
Importance of Human Resource in Management:-There are ample
reasons to point out the importance of human resource management in
an organization
1. Helps you achieve your objectives: The chief ground for human
resource management to be important is that they help the company to
achieve their objective on a regular basis by means of developing a
positive attitude amongst the employees. They assist in diminishing
wastages and make usage of maximum net income from the
resources.
2. Design recruitment and training: They are significant because
they cull the right kind of people during recruitment. They call for
initiatives and design criteria which are best suited for a specific task.
When required they also supply preparation for employees, which
helps in evolving the presentation skills of the employees and then
they take up new posts.
3. Professional development is attained: The policies adopted by
human resource management helps in providing excellent training for
the employees. When such training is offered, they are developed
professionally. Their talent can be used inside the system and also in
other companies which one may intend to join in the future.
4. Performance appraisals are a good thing: The HRM motivates
the employees by their performance assessment procedure. They help
people to act according to their efficacy and also offer estimates to
gain advances. The employee’s performances according to their roles
are monitored on a regular base. With this concept the employees are
able to make an outline of their ends and go towards it. By this way
the employees are boosted and perform good.
5. Smooth relationship is preserved: The co-ordinal relationship
between union and management is maintained with HRM. The joins

in the troupe comes to a determination that the troupe is also
interested in their increment and the prospects for performing strikes
are greatly brought down.
6. The work atmosphere is maintained: Another important aspect to
be glanced is that the workplace atmosphere and work culture are
significant aspects which plays a central part in the operation of an
employee. The human resource team offers a good working condition
for the employees. A dependable, tidy and clean employee can take
out the best performance from an employee. Apart from this job
satisfaction is also obtained with a good work environment.
7. Enhances team work: The HRM helps individuals and trains them
to play in a team; this perfect training makes employees better to
exploit in a team. By this way team work is enhanced and employees
learn to adjust and coordinate with their squad.
8. Handles disputes: There are a number of hassles and issues that
may rise up during the track amongst the employer and employee in
an organization. In such scenarios, the human resource department
acts as a consultant as well as intercessor to set right those sorts of
events. They first hear the grievances of the employees and sort them
out by providing proper solution. Whenever mandatory, they also
require immediate action.
9. They prepare talents for the hereafter: To integrate the
occupation demands and produce perfect results, the employees are
often trained. During the training period the potential employees of
the team are distinguished to be advanced to the next higher grade. So
HRM takes responsibility for preparing people for the future by
picking talents.
10. Public relations are raised: The human resource management is
responsible for rising public relations during the class of work. They
are responsible for organizing seminars, business meetings, and other
official get together on behalf of the fellowship so that public
relationship with other systems is developed. Commercial enterprise
and marketing plans are likewise planned by human resource
management in some shells. Hence they help in preparing and
maintaining public relationships.

11. They select the right employee: The human resource
management follows a certain set of protocols to pick the correct
candidate for a fixed task. Such sort of selection offers job satisfaction
for the employee as they act in the proper class of occupation. The
routine of employees who leave their occupation is also reduced,
which decreases labor turnover.
12. For handling payrolls: Either small business or large systems,
human resource managements help in maintaining payrolls or
handling open enrollment season each year. The employee’s complete
details regarding payments are taken charge by this squad. They too
hire up the obligation to set the pay range within the establishment.
13. They maintain management cost: The HRM trims down the
management cost with various methods and brings about best
methods for benefits where few of them include health care coverage.
The human resource management also makes a detailed study on the
current status regarding wage setting, by running through the labor
market, employee trends and salary analysis with the equivalent job
functions. For budget constrained organizations human resource
management can be a perfect solution.
14. Minimizing employee recruitment cost: The cost of recruitment,
replacement, training and ramp up time can be outrageous for
organization especially for small businesses. But the HRM would
design a well-structured recruitment and selection process which
helps in minimizing the key expenses regarding job advertisements,
training and enrolling new employees.
15. Helps you get latest salary:Another important reason for human
resource management to play a key role is that they recommend in
gaining market based salaries, they determine salary ranges for their
organization with the latest updates and knowledge.
16. They take in a great deal of benefits: The HR team researches
bring in latest updates and recommends for more of employee welfare
programs so that employees are benefited. When such employee
benefit programs are brought to light, the employees are impressed
and stay in the system.
17. Human resource brings in joy within the employees: The
human resource team is the one who takes up responsibility for

events, activities, celebrations, theater trips, ceremonies and other
team development opportunities. The HR manager is the one who
manages the budget and organizes the event. This brings in joy and
relaxation amongst employees apart from work schedule.
18. They take hands and lead you in a new way: When your
organization has declared for introducing new products, deviating
towards new goals, changing directions, the human resource team is
the one who precedes them with the new process and plans. They are
considered important as they are responsible for advocating and
carrying out strategies for the fellowship as well as the society. With
the new mission the human resource also helps in achieving strategic
goals.
19. Human resource management recommends using the
resources: The human resource management makes certain that they
make proper use of all the available human and non-human resources.
When such available resources are utilized properly, goals of an
organization is accomplished. Societies who are developed to make
proper utilization of their resources invite the human resource
management to plan for objectives and policies.
20. Organizational structuring: The relationship carried on between
the employees and management is fixed with the help of
organizational structure. It is the one which assigns tasks for each
employee within the establishment. The projects to be delegated
should be within the stipulated constraint which also packs into
account location, responsibilities, accountability and other
relationships within the system. The human resource management
plays a key role here by supplying exact and timely data. In this
manner human resource management maintains organizational
structure.
21. Humans are respected: The human resource management is
considered significant as they provide a respectful environment for
the employees. The human resource management makes sure that
each employee is provided with respect and facilities which avoids
dominating tendency which in turn avoids organizational crisis. In
this aspect proper respect is gained at work station. With respect
amongst employees, a safe working environment is upheld.

22. Setting goals is important: On that point is an individual goal as
well as organizational goal within the employer’s judgment. When
employees have such a goal conflict, they are not able to perform
well, h
Features of HRM
It is an art and a science:
The art and science of HRM is indeed very complex. HRM is both the
art of managing people by recourse to creative and innovative
approaches; it is a science as well because of the precision and
rigorous application of theory that is required.
2. It is pervasive:
Development of HRM covers all levels and all categories of people,
and management and operational staff. No discrimination is made
between any levels or categories. All those who are managers have to
perform HRM. It is pervasive also because it is required in every
department of the organisation. All kinds of organisations, profit or
non-profit making, have to follow HRM.
3. It is a continuous process:
First, it is a process as there are number of functions to be performed
in a series, beginning with human resource planning to recruitment to
selection, to training to performance appraisal.
To be specific, the HRM process includes acquisition (HR planning,
recruitment, selection, placement, socialisation), development
(training and development, and career development), utilisation (job
design, motivation, performance appraisal and reward management),
and maintenance (labour relations, employee discipline, grievance
handling, welfare, and termination). Second, it is continuous, because
HRM is a never-ending process.
4. HRM is a service function:
HRM is not a profit centre. It serves all other functional departments.
But the basic responsibility always lies with the line managers. HRM
is a staff function – a facilitator. The HR Manager has line authority
only within his own department, but has staff authority as far as other
departments are concerned.

5. HRM must be regulation-friendly:
The HRM function has to be discharged in a manner that legal
dictates are not violated. Equal opportunity and equal pay for all,
inclusion of communities in employment, inclusion of tribal’s (like
Posco or Vedanta projects) and farmers in the benefits and non-
violation of human rights must be taken care of by the HRM.
6. Interdisciplinary and fast changing:
It is encompassing welfare, manpower, personnel management, and
keeps close association with employee and industrial relations. It is
multi- disciplinary activity utilising knowledge and inputs from
psychology, sociology, economics, etc. It is changing itself in
accordance with the changing environment. It has travelled from
exploitation of workers to treating them as equal partners in the task.
7. Focus on results:
HRM is performance oriented. It has its focus on results, rather than
on rules. It encourages people to give their 100%. It tries to secure the
best from people by winning the whole hearted cooperation. It is a
process of bringing people and organization together so that the goals
of each are met. It is commitment oriented.
8. People-centred:
HRM is about people at work both as individuals and a group. It tries
to help employees to develop their potential fully. It comprises
people-related functions like hiring, training and development,
performance appraisal, working environment, etc.
HRM has the responsibility of building human capital. People are
vital for achieving organizational goals. Organizational performance
depends on the quality of people and employees.
9. Human relations philosophy:
HRM is a philosophy and the basic assumption is that employees are
human beings and not a factor of production like land, labour or
capital. HRM recognises individuality and individual differences.
Every manager to be successful must possess social skills to manage
people with differing needs.
10. An integrated concept:
HRM in its scope includes Personnel aspect, Welfare aspect and
Industrial relations aspect in itself. It is also integrated as it concern

with not only acquisition, but also development, utilization, and
maintenance.
Evolution of HRM
The evolution of the concept of Human Resource Management is
presented below
Period before industrial revolution – The society was primarily an
agriculture economy with limited production. Number of specialized
crafts was limited and was usually carried out within a village or
community with apprentices assisting the master craftsmen.
Communication channel were limited.
Period of industrial revolution (1750 to 1850) – Industrial
revolution marked the conversion of economy from agriculture based
to industry based. Modernization and increased means if
communication gave way to industrial setup. A department was set
up to look into workers wages, welfare and other related issues. This
led to emergence of personnel management with the major task as
– Worker’s wages and salaries
– Worker’s record maintenance
– Worker’s housing facilities and health care
An important event in industrial revolution was growth of Labour
Union (1790) – The works working in the industries or factories were
subjected to long working hours and very less wages. With growing
unrest , workers across the world started protest and this led to the
establishment of Labour unions. To deal with labour issues at one end
and management at the other Personnel Management department had
to be capable of politics and diplomacy , thus the industrial relation
department emerged.
Post Industrial revolution – The term Human resource Management
saw a major evolution after 1850. Various studies were released and
many experiments were conducted during this period which gave
HRM altogether a new meaning and importance.
A brief overview of major theories release during this period is
presented below
 Frederick W. Taylor gave principles of scientific management
(1857 o 1911) led to the evolution of scientific human resource
management approach which was involved in

– Worker’s training
– Maintaining wage uniformity
– Focus on attaining better productivity.
 Hawthorne studies, conducted by Elton Mayo & Fritz
Roethlisberger (1927 to 1940). – Observations and findings of
Hawthrone experiment shifted the focus of Human resource from
increasing worker’s productivity to increasing worker’s efficiency
through greater work satisfaction.
 Douglas McGregor Theory X and Theory Y (1960) and
Abraham Maslow’s Hierarchy of needs ( 1954) – These studies and
observations led to the transition from the administrative and
passive Personnel Management approach to a more dynamic
Human Resource Management approach which considered workers
as a valuable resource.
As a result of these principles and studies , Human resource
management became increasingly line management function , linked
to core business operations. Some of the major activities of HR
department are listed as-
1. Recruitment and selection of skilled workforce.
2. Motivation and employee benefits
3. Training and development of workforce
4. Performance related salaries and appraisals.
Strategic Human Resource Management Approach
With increase in technology and knowledge base industries and as a
result of global competition , Human Resource Management is
assuming more critical role today . Its major accomplishment is
aligning individual goals and objectives with corporate goals and
objectives. Strategic HRM focuses on actions that differentiate the
organization from its competitors and aims to make long term impact
on the success of organization.

HR AS A FACTOR OF COMPETITIVE ADVANTAGE
Human resource professionals vary in the kinds of skills and
experience they bring to a job. Many are administrators proficient at
processing payroll and executing benefits programs, but have little
more leadership status than your clerical workers. You can upgrade
your HR department to include recruitment specialists who also
understand your company’s strategic roles and can play an integral
part in shaping your business success. Executive-level human
resource professionals can help design job descriptions and training
programs, advise you on where to find the best candidates, and
participate in defining salary levels that will result in the best new
hires.
Give HR Leadership Positions
The human resource department often is given job descriptions and
told to fill the positions. Salaries are predetermined and the HR staff
has little or no input into the hiring process. To tap into the HR
professional’s insights, you should bring your human resource
manager into the hiring process more completely. Allow HR to play a
role in determining appropriate recruitment pay and tactics, let you
know how much it takes to recruit top talent, and how company
policies can be amended to recruit the best.
Let HR Determine Training Programs
With an HR department that participates in defining and
implementing company goals, you can rely on your human resources
team to consider the company’s profitability with each decision they
make. In addition to defining employee jobs and required

qualifications, an actively participatory HR department can monitor
employee activity levels, morale and customer service success to
design and implement appropriate training programs with line
supervisors and executive management teams.
Provide HR Tools to Monitor Employee Performance
The human resource department can build programs to track those
employees who stand out. When your human resource professionals
are involved in designing and providing employee reviews, they can
help you spot talent and advise you on how you can best groom
employees for promotions. They can provide designated employees
with specific training and help you devise opportunities for growth,
serving as your eyes and ears for seeking out the best candidates that
will push your company into a competitive advantage.
LINE AD STAFF RESPONSIBILITY OF HR MANAGERS
Line Authority
Line authority proceeds from top to bottom through the chain of
command. Line authority grants a manager or executive a definite
level of power concerning the performance of a specific business task.
Human resources managers have line authority by virtue of their
power over the HR department. They consult with human resources
staffers on hiring decisions and dictate policies on acquiring new
talent, creating benefits packages and crafting termination procedures.
Staff Authority
Staff authority gives some managers the power to offer advice or
suggestions to those managers with line authority, which includes the
right to propose new ideas in an attempt to make improvements in
line operations. While managers with staff authority do not have the
same direct power over subordinates as those with line authority, they
can provide useful propositions. Human resources managers have
staff authority in nearly every department, because they provide
advice and proposals on hiring levels, budgets and qualifications for
new employees.
COMPETENCIES OF HR MANAGER

1. Human Resources Knowledge
Today’s job seekers have access to more information than ever
before. Therefore, the best HR professionals must be prepared to meet
these informed candidates with industry expertise of their own.
Understanding how and why individuals enter and move within an
organization is at the core of everything else you will do in human
resources. HR managers who truly add value are always attuned to
“the big picture” of how HR practices relate to a successful business.
Your knowledge in this area needs to be greater than anyone else’s to
support the objectives of employees and employers alike. After all,
HR management is not just about talent acquisition, but also about
retention.
2. A Commitment to Ongoing HR Learning
Today’s business landscape is complex and in a state of constant flux.
The field of HR is dynamic and our ability to process and understand
it needs self-motivation.
Growing in your job means being receptive to new ideas, wherever
they may come from. Have you demonstrated a commitment to
ongoing learning by taking advantage of conferences, other
colleagues in HR, or graduate studies?
HR professionals who never stop learning are well-positioned to
translate well thought out industry trends and data into actionable
insights.
3. Communication Skills in Human Resources
The primary function of the typical HR professional’s job involves
facilitating discussion between employees and employers. If a human
resources manager can’t communicate clearly they will not be
successful. Both oral and written skill are required to effectively relay
information.
One aspect of communication that gives people an edge is a strong
ability for conflict resolution. Even in the most agreeable workplaces,
problems arise that need a diplomatic ear, an eye for assessment, and
a hand for getting the problem settled. This particular skill is
invaluable when negotiating solutions and keeping things on track.

4. Critical Thinking Skills
Critical thinking is in the “sweet spot” of less common/more desired
employed traits, according to an analysis of the skills gap
by Bloomberg. HR professionals, in particular, frequently need to
balance complex situations and take their time to think with a
combination set-in-stone processes and outside-the-box thinking.
Employees come from a breadth and depth of backgrounds and
experiences. HR professionals need to strategically cultivate an
environment in which all can work together toward the improvement
of the business.
5. An Ethical Approach for Human Resources
The importance of ethics as an HR core competency cannot be
overstated. Every day, HR professionals face ethical challenges
related to everything from managing private employee information to
protecting the reputation of their organizations. Adopting an
unwavering and unilateral commitment to ethics not only helps attract
top talent while safeguarding your organization, but also fosters a
culture of trust and loyalty.
Part of being ethical is truly caring about people. Empathy for tough
situations and “real life” goes a long way to setting you apart from
those who just do it “by the book.”
Some ethical principles are enshrined in law. Making sure your
company’s policies and practices are in legal compliance is a
mainstay in the world of human resources. Avoiding discrimination in
regard to ethnic background, disability, religious belief, and many
other factors is important because of the hurt it will avoid and to
foster a better, more diverse work environment.
Laws are always changing, sometimes incrementally, sometimes as
part of a great cultural shift. Therefore, staying up to date on national
news, trends, and laws is particularly important; ignorance of the law
is not a winning defense. Legal compliance, of course, also protects
the company and its officers.
6. Human Resources Organizational Skills
HR management is a juggling act. The more organized you are, the
better you’ll be able to stay ahead of what you need to do and have
time for things you would like to do. If you think organization is

something you either have or you don’t, think again. Organization can
be honed by understanding where you work, and doing a few things
the same every day to build a routine.
While these six HR core competencies may seem like a tall order,
they’re embodied by the best HR managers in workplaces across the
country. Great work experience can help, but that takes time.
A Master of Science in Human Resources Management helps develop
all these skills quickly. Not only will an advanced degree help you
develop a richer understanding of how to be a better HR leader, but
you’ll learn how to apply these skills appropriately for success.
STRATEGIC HRM
Strategic management is the process of formulating, implementing
and evaluating business strategies to achieve organisational
objectives. Cunningham’ has defined strategic management as a
manner by which organisations plan to deal with the various aspects
of management like problem perception, divergent thinking,
substantial resources, decisions making, innovations, taking risks and
facing uncertainty. Meaning of strategic HRM: Human Resource
Management The best way to understand strategic human resources
management is by comparing it to human resource management.
Human resource management (HRM) focuses on recruiting and hiring
the best employees and providing them with the compensation,
benefits, training, and development they need to be successful within
an organization. However, strategic human resource management
takes these responsibilities one step further by aligning them with the
goals of other departments and overall organizational goals. HR
departments that practice strategic management also ensure that all of
their objectives are aligned with the mission, vision, values, and goals
of the organization of which they are a part. Strategic Human
Resource Management Strategic human resource management is the
practice of attracting, developing, rewarding, and retaining employees
for the benefit of both the employees as individuals and the
organization as a whole. HR departments that practice strategic
human resource management do not work independently within a silo;
they interact with other departments within an organization in order to

understand their goals and then create strategies that align with those
objectives, as well as those of the organization. As a result, the goals
of a human resource department reflect and support the goals of the
rest of the organization. Strategic HRM is seen as a partner in
organizational success, as opposed to a necessity for legal compliance
or compensation. Strategic HRM utilizes the talent and opportunity
within the human resources department to make other departments
stronger and more effective. Importance of Strategic HRM When a
human resource department strategically develops its plans for
recruitment, training, and compensation based on the goals of the
organization, it is ensuring a greater chance of organizational success.
Let's think about this approach in relation to a basketball team, where
Player A is the strategic HR department, and Players B through E are
the other departments within the organization. The whole team wants
to win the ball game, and they all may be phenomenal players on their
own, but one great player doesn't always win the game. If you've
watched a lot of sports, you understand that five great players won't
win the game if each one of those five great players is focused on
being the MVP. That's not how a basketball team wins, and it's not
how an organization wins either. A team wins when its members
support each other and work together for a common goal. Player A,
our strategic HR department, must work with players B, C, D and E,
our different organizational departments. They must run plays that
they have planned out beforehand, assist when necessary to help
another player get the basket, and compensate for the weaknesses of
one in order to create a stronger team as a whole. When a team works
together to reach that common goal, only then can they be truly
successful. You could also look at strategic HRM as the team captain
or coach, as his or her responsibilities are a little bit different from
those of the other players. Human resources departments are charged
with analyzing the changes that need to occur with each 'player' or
department and assisting them in strengthening any weaknesses.
Strategic human resource management then is the process of using
HR techniques, like training, recruitment, compensation, and
employee relations to create a stronger organization, one employee at
a time.

Strategic HRM, therefore, is concerned with the following:
1. Analyse the opportunities and threats existing in the external
environment.
2. Formulate strategies that will match the organisation’s (internal)
strengths and weaknesses with environmental (external) threats and
opportunities. In other words, make a SWOT analysis of organisation.
3. Implement the strategies so formulated.
4. Evaluate and control activities to ensure that organisation’s
objectives are duly achieved. Benefits of strategic management: The
strategic HR framework aims to leverage and / or align HR practices
to build critical capabilities that enable an organisation to achieve its
goals. Strategic management offers both financial and non-financial
benefits to an organization which practices it.
Fred R. David’ has listed the following benefits that strategic
management brings for an organization:
1. Allows identification, prioritization and exploitation of
opportunities.
2. Provides an objective view of management problems.
3. Represents a framework for improved co-ordination and control of
activities.
4. Minimizes the effects of adverse conditions and changes.
5. Allows major decisions to better support established objectives.
6. Allows more effective allocation of time and resources to identified
opportunities.
7. Allows fewer resources and lesser time to be devoted to correcting
erroneous or adhoc decisions.
8. Creates a framework for internal communication among personnel.
9. Helps to integrate the behaviors of individuals into a total effort.
10. Provides a basis for the clarification of individual responsibilities.
11. Gives encouragement to forward thinking.
12. Provides a co-operative, integrated and enthusiastic approach to
tackling problems and opportunities.
13. Encourages a favourable attitude towards change.
14. Gives a degree of discipline and formality to the management of a
business. Role of HRM in strategic management: We have already

mentioned that strategic business plan is formulated to achieve
competitive advantage.
From this specific strategy for each functional area viz., marketing,
finance, production operations and human resources need to be drawn
in alignment with strategic business plan to carry out the
organisational plan. In other words, the formulation of organisational
strategy is integrative with the formulation of functional strategies.
Here, human resource strategy assumes more importance because it
provides human resources for other functional areas also. Lengnick
Hall and Lengnick- Hall in this respect argue in ‘Strategic Human
Resource Management’ that reciprocal interdependence between an
organisation’s business strategy and human resource strategy
underlines the proposed approaches to the strategic management of
human resources. This suggests that we must recognize that human
resources integrally affect the overall strategy of an organisation.
With this in mind, we are now discussing the integrative role played
by human resources in the strategic management of an organisation.
Strategic human resource planning: Human resource planning is a
process that identifies current and future human resources needs for
an organization to achieve its goals. Human resource planning should
serve as a link between human resource management and the overall
strategic plan of an organization. Ageing workers population in most
western countries and growing demands for qualified workers in
developing economies have underscored the importance of effective
human resources planning.
As defined by Bulla and Scott, human resource planning is 'the
process for ensuring that the human resource requirements of an
organization are identified and plans are made for satisfying those
requirements'.[
1] Reilly defined workforce planning as: 'A process in which an
organization attempts to estimate the demand for labour and evaluate
the size, nature and sources of supply which will be required to meet
the demand.'
[2] Human resource planning includes creating an employer brand,
retention strategy, absence management strategy, flexibility strategy,
talent management strategy, recruitment and selection strategy. The

planning processes of most best practice organizations not only define
what will be accomplished within a given time-frame, but also the
numbers and types of human resources that will be needed to achieve
the defined business goals (e.g., number of human resources; the
required competencies; when the resources will be needed; etc.).
Competency-based management supports the integration of human
resources planning with business planning by allowing organizations
to assess the current human resource capacity based on their
competencies against the capacity needed to achieve the vision,
mission and business goals of the organization. Targeted human
resource strategies, plans and programs to address gaps (e.g., hiring /
staffing; learning; career development; succession management; etc.)
are then designed, developed and implemented to close the gaps.
These strategies and programs are monitored and evaluated on a
regular basis to ensure that they are moving the organizations in the
desired direction, including closing employee competency gaps, and
corrections are made as needed.
This Strategic HR Planning and evaluation cycle is depicted in the
diagram below.
Human resource planning is the ongoing process of systematic
planning to achieve the best use of an organisation's most valuable
asset – its human resources. The objective of human resource (HR)
planning is to ensure the best fit between employees and jobs, while
avoiding workforce shortages or spares.
The three key elements of the HR planning process are forecasting
labour demand, analysing present labour supply, and balancing
projected labour demand and supply. Implementation stages
1. Assessing the current HR capacity
• Develop a skills catalog for your employees so that you have a clear
understanding of what your staff currently holds. This employee
catalog should include everything from volunteer activities to
certifications, of all degrees not just topics pertaining to their
particular position. These catalogs can be assessed to deem whether or
not an employee is ready to add more responsibility, or to forecast the
employee's future development plans.
2. Forecasting HR requirements

• This step includes projecting what the HR needs for the future will
be based on the strategic goals of the organization. Keep in mind you
will need to also accommodate for external challenges that can affect
your organization.
• Some questions to ask during this stage include: Which jobs will
need to be filled in the upcoming period? What skill sets will people
need?
How many staff will be required to meet the strategic goals of our
organization? Is the economy affecting our work and ability to appeal
to new employees? How is our community evolving or expected to
change in the upcoming period? 3. Gap analysis
• During this step you will observe where your organization is
currently, and where you want to be in the future. You will identify
things such as, the employee count, and the skills evaluation and
compare it to what will be needed to achieve your future goal. During
this phase you should also review your current HR practices and
identify what you are doing that is useful and what you can add, that
will help you achieve your goal.
• Questions to answer in this stage include:
What new jobs will we need?
What new skills will we need? Do our present employees have the
necessary skills?
Are employees currently aligned to their strengths? Are current HR
practices adequate to meet our future goal?
4. Developing HR strategies to support the strategies of the
organization.
• There are 5 HR strategies that you can follow to meet your
organizational goals. Restructuring strategies
 This includes reducing staff, regrouping tasks to create well-
designed jobs, and reorganizing work groups to perform more
efficiently. Training and development strategies
 This includes providing the current staff with training and
development opportunities to encompass new roles in the
organization Recruitment strategies
 This includes recruiting new hires that already have the skills the
organization will need in the future. o Outsourcing strategies
 This includes outreaching to external individuals or organizations
to complete certain tasks. o Collaboration strategies
 This includes collaborating with other organizations to learn from
how others do things, allow employees to gain skills and knowledge
not previously available in their own organization. How Does HRM
Influence Organizational Performance?
● Effective HRM systems increase an organization’s ability to meet
its goals, enhance its ability to grow and manage change, and increase
employee engagement, effort, and performance.
● Managing HR helps organizations with strategic risk, operational
risk, financial risk, and compliance risk. The most effective HRM
systems are based on solid research, identifying and implementing
best practices, and aligning the HRM system with organizational
goals and environmental realities.
DIFFERENCE BETWEEN SHRM AND HRM.
The term HRM expands to Human Resource Management; it implies
the implementation of management principles for managing the
workforce of an organisation. It is concerned with the process of
hiring, developing and retaining the manpower, with a view to
making them more efficient. When conventional HRM is compared
and contrasted with the strategic HRM or SHRM, it becomes easier to
understand.
SHRM is the process of aligning the business strategy with the
company’s human resource practices, so as to attain strategic goals of
an organization. In SHRM, the workforce of the company is managed
proactively. Take a glance at the article presented here that explains
the difference between HRM and SHRM.
Comparison Chart
BASIS FOR
HRM SHRM
COMPARISON
Meaning Human resource SHRM is a managerial

management (HRM) implies function which implies
the governance of framing of HR strategies in
manpower of the such a way to direct
organization in a thorough employees efforts towards the
and structured manner. goals of organization.

BASIS FOR
HRM SHRM
COMPARISON
Nature Reactive Proactive
Responsibility lies Staff specialist Line manager

with
Approach Fragmented Integrated
Scope Concerned with employee Concerned with internal and

relations external relations
Time horizon Short term Long term
Basic factor Capital and products People and knowledge
Change Follows change Initiates change
Accountability Cost center Investment center
Control Stringent control over It exhibits leniency.

employees
Key Differences Between HRM and SHRM
The differences between HRM and SHRM can be drawn clearly on
the following grounds:
1. The governance of manpower of the organisation in a thorough
and structured manner is called Human Resource Management or
HRM. A managerial function which implies framing of HR strategies
in such a way to direct employees efforts towards the goals of an
organisation is known as SHRM.
2. The process of HRM is reactive in nature. On the other hand,
SHRM is a proactive management function.
3. In human resource management, the responsibility of manpower
lies with the staff specialists, whereas in strategic human resource
management, the task of managing the workforce, is vested in the line
managers.
4. HRM follows fragmented approach, which stresses on applying
management principles while managing people in an organisation. As

against this, SHRM follows an integrated approach, which involves
lining up of business strategy with the company’s HR practices.
5. Human resource management emphasises on employee
relations, ensuring employees motivation, and also the firm conforms
to the necessary employment laws. Conversely, SHRM focuses on a
partnership with internal and external constituent groups.
6. HRM supports short-term business goals and outcomes, but
SHRM supports long-term goals and results of business.
7. In human resource management, the human resource manager
plays the role of change follower, i.e. he/she responses to change,
hence pursues transactional leadership style. As opposed to SHRM,
the human resource manager is a change leader, i.e. an imitator, thus
seeks transformational leadership.
8. The primary element in HRM is the capital and products, but
people and their knowledge are the building blocks of SHRM.
9. If we talk about accountability, a conventional HRM is a cost
centre. Unlike a strategic HRM which is an investment centre.
10. In human resource management, stringent control over
employees is exercised. As against this, in strategic human resource
management, no such control is imposed, rather the rules for
managing manpower is lenient.
HRM ENVIRONMENT AND ENVIRONMENT SCANNING
Organizational environment consists of both external and internal
factors. Environment must be scanned so as to determine
development and forecasts of factors that will influence
organizational success. Environmental scanning refers to
possession and utilization of information about occasions,
patterns, trends, and relationships within an organization’s
internal and external environment. It helps the managers to decide
the future path of the organization. Scanning must identify the threats
and opportunities existing in the environment. While strategy
formulation, an organization must take advantage of the opportunities
and minimize the threats. A threat for one organization may be an
opportunity for another.
Internal analysis of the environment is the first step of environment
scanning. Organizations should observe the internal organizational

environment. This includes employee interaction with other
employees, employee interaction with management, manager
interaction with other managers, and management interaction with
shareholders, access to natural resources, brand awareness,
organizational structure, main staff, operational potential, etc. Also,
discussions, interviews, and surveys can be used to assess the internal
environment. Analysis of internal environment helps in identifying
strengths and weaknesses of an organization.
As business becomes more competitive, and there are rapid changes
in the external environment, information from external environment
adds crucial elements to the effectiveness of long-term plans. As
environment is dynamic, it becomes essential to identify competitors’
moves and actions. Organizations have also to update the core
competencies and internal environment as per external environment.
Environmental factors are infinite, hence, organization should be agile
and vigile to accept and adjust to the environmental changes. For
instance - Monitoring might indicate that an original forecast of the
prices of the raw materials that are involved in the product are no
more credible, which could imply the requirement for more focused
scanning, forecasting and analysis to create a more trustworthy
prediction about the input costs. In a similar manner, there can be
changes in factors such as competitor’s activities, technology, market
tastes and preferences.
While in external analysis, three correlated environment should be
studied and analyzed —
 immediate / industry environment
 national environment
 broader socio-economic environment / macro-environment
Examining the industry environment needs an appraisal of the
competitive structure of the organization’s industry, including the
competitive position of a particular organization and it’s main rivals.
Also, an assessment of the nature, stage, dynamics and history of the
industry is essential. It also implies evaluating the effect of
globalization on competition within the industry. Analyzing
the national environment needs an appraisal of whether the national
framework helps in achieving competitive advantage in the globalized

environment. Analysis of macro-environment includes exploring
macro-economic, social, government, legal, technological and
international factors that may influence the environment. The analysis
of organization’s external environment reveals opportunities and
threats for an organization.
Strategic managers must not only recognize the present state of the
environment and their industry but also be able to predict its future
positions.
Internal Environment:
These are the forces internal to an organisation. Internal forces have
profound influence on HR functions. The internal environment of
HRM consists of unions, organizational culture and conflict,
professional bodies, organisational objectives, polices, etc. A brief
mention of these follows.
Unions:
Trade unions are formed to safeguard the interest of its
members/workers. HR activities like recruitment, selection, training,
compensation, industrial relations and separations are carried out in
consultation with trade union leaders.
Organisational Culture and Conflict:
As individuals have personality, organizations have cultures. Each
organisation has its own culture that distinguishes one organisation
from another. Culture may be understood as sharing of some core
values or beliefs by the members of the organisation “Value for time”
are the culture of Reliance Industries Limited. The culture of Tata
conglomerate is “get the best people and set them free”.
HR practices need to be implemented that best fit the organisation’s
culture. There is often conflict between organizational culture and
employee’s attitude. Conflict usually surfaces because of dualities
such as personal goal vs. organisational goal, discipline vs. autonomy,
rights vs. duties, etc. Such conflicts have their bearings on HR
activities in an organisation.
Professional Bodies:
Like other professional bodies, the NIPM as the HR professional body
regulates the functions of HR practitioners in India. For this the NIPM
in of ethics which the HR practitioners are expected to declare their

allegiance to the code (see Figure 2.2). Thus, professional bodies also
influence HR functions of an organization.
External Environment:
External environment includes forces like economic, political,
technological, demographic etc. these exert considerable influence on
HRM. Each of these external forces is examined here.
Economic:
Economic forces include growth rate and strategy, industrial
production, national and per capita incomes, money and capital
markets, competitions, industrial labour and globalisation. All these
forces have significant influence on wage and salary levels. Growing
unemployment and reservation in employment also affect the choice
for recruitment and selection of employees in organisations.
Political:
Political environment covers the impact of political institutions on
HRM practices. For example, democratic political system increases
the expectations of workers for their well being.
The total political environment is composed of three institutions:
1. Legislature:
This is called Parliament at the central level and Assembly at the state
level A plethora of labour laws are enacted by the legislature to
regulate working conditions and employment relations.
2. Executive:
It is the Government that implements the law. In other words, the
legislature decides and the executive acts.
3. Judiciary:
This is like a watchdog above the two. It ensures that both the
legislature and the executive work within the confines of the
constitution and also in the overall interest of the people. These affect,
in one way or the other, all HR activities from planning to placement
to training to retention and maintenance.
Technological:
Technology is a systematic application of organised knowledge to
practical tasks.
Technological advances affect the HR functions in more than one
way:

First; technology makes the job more intellectual or upgraded.
Second, it renders workers dislocated if they do not equip themselves
to the job.
Third, job becomes challenging for the employees who cope with the
requirements of technology Fourth, technology reduces human
interaction at the work place. Finally job-holders become highly
professionalized and knowledgeable in the job they perform.
Demographic:
Demographic variables include sex, age, literacy, mobility, etc.
Modem work force is characterized by literate, women and scheduled
caste and scheduled tides workers. Now, workers are called
knowledge workers’ and the organisations wherein they work are
called ‘knowledge organisations’.
As such, the traditional line of distinction between manual and non-
manual workers is getting blurred. Employees are demanding parity
in remuneration and responsibility among various categories and
levels of employees.
MAN POWER PLANNING
Definitions of Human Resource Planning - HRP
1. Colemn has defined human resource planning as "the process of
determining manpower requirements and the means for meeting those
requirements in order to carry an integrated plan at the organisation".
2. Stainer defines manpower planning as "strategy for the
acquisition, utilisation, improvement and preservation of an
enterprise's human resources. It relates to establishing job
specifications or the quantitative requirements of jobs determining the
number of personnel required and developing resources of
manpower".
Objectives of Manpower / HR Planning
1. To ensure optimum utilisation of human resources currently
employed in the Organisation.
2. To determine the future manpower requirements of the
Organisation as per the need for renovations, modernisation,
expansion and growth programmes.
3. To determine the recruitment level.

4. To ensure that necessary human resources are available as and
when required.
5. To assess future accommodation requirements.
6. To design the basis for management development programmes
so as to develop the required talents among the employees selected.
Advantages / Importance of HRP
1. Meeting manpower needs : Every Organisation needs adequate
and properly qualified staff for the conduct of regular business
activities. Imaginative HRP is needed in order to meet the growing
and changing human resource needs of an organisation.
2. Replacement of manpower : The existing manpower in an
Organisation is affected due to various reasons such as retirement and
removal of employees and labour turnover. HRP is needed to estimate
the shortfall in the manpower requirement and also for making
suitable arrangements for the recruitment and appointment of new
staff.
3. Meeting growing manpower needs : The expansion or
modernisationprogramme may be undertaken by the enterprise.
Manpower planning is needed in order to forecast and meet additional
manpower requirement due to expansion and growth needs through
recruitment and suitable training programmes.
4. Meeting challenges of technological environment : HRP is
helpful in effective use of technological progress. To meet the
challenge of new technology existing employees need to be retrained
and new employees may be recruited.
5. Coping with change : HRP enables an enterprise to cope with
changes in competitive forces, markets, products, and technology and
government regulations. Such changes generate changes in job
content, skill, number and type of personals.
6. Increasing investment in HR : An employee who picks up skills
and abilities becomes a valuable resource because an organisation
makes investments in its manpower either through direct training or
job assignments.
7. Adjusting manpower requirements : A situation may develop in;
an organisation when there will be surplus staff in one department and

shortage of staff in some other department. Transfers and promotions
are made for meeting such situations.
8. Recruitment and selection of employees : HRP suggests the type
of manpower required in an organisation with necessary details. This
facilitates recruitment and selection of suitable personnel for jobs in
the Organisation. Introduction of appropriate selection tests and
procedures is also possible as per the manpower requirements.
9. Placement of manpower : HRP is needed as it facilitates
placement of newly selected persons in different departments as per
the qualifications and also as per the need of different departments.
Surplus or shortage of manpower is avoided and this ensures optimum
utilisation of available manpower.
10. Training of manpower : HRP is helpful in selection and training
activities. It ensures that adequate number of persons are trained to fill
up the future vacancies in the Organisation.
Meaning of Job Analysis
Job analysis is prior to recruitment. Job means a task or a specific
activity to be performed in one or the other department of a
production unit. Clear understanding of the job is called job analysis.
It creates a proper background for recruitment and selection. Job
analysis is the process of collecting all relevant information relating to
the job. This information relates to the nature and features of a job
and the qualities and qualifications required for performing the job
efficiently. Job analysis provides basic information which facilitates
scientific recruitment and selection.
DEFNITION:-
According to Edwin Flippo, "Job analysis is the process of studying
and collecting information relating to the operations and
responsibility of a specific job." Job analysis is based on job data.
Hence the question: how to collect job related data? A variety of
methods are available for collecting job data.The method that was
historically linked to the concept of job analysis was observation
supplemented by the interview.
METHODS OF JOB ANALYSIS
1.Observation

When the observation method is used, a manager, job analyst, or
industrial engineer observes the individual performing the job and
takes notes to describe the tasks and duties performed. Observation
may be continuous or based on intermittent sampling.
Use of the observation method is limited because many jobs do not
have complete and easily observed job duties or complete job cycles.
Thus, observation may be more useful for repetitive jobs and in
conjunction with other methods.
Managers or job analysts using other methods may watch parts of a
job being performed to gain a general familiarity with the job and the
conditions under which it is performed. Multiple observations on
several occasions also will help them use some of the other job
analysis methods more effectively.
2.WORK SAMPLING
As a type of observation, work sampling does not require attention to
each detailed action throughout an entire work cycle. Instead, a
manager can determine the content and pace of a typical workday
through statistical sampling of certain actions rather than through
continuous observation and timing of all actions. Work sampling is
particularly useful for routine and repetitive jobs.
3.EMPLOYEE DIARY/LOG
Another method requires that employees “observe” their own
performances by keeping a diary/log of their job duties, noting how
frequently they are performed and the time required for each duty.
Although this approach sometimes generates useful information, it
may be burdensome for employees
to compile an accurate log. Also, employees sometimes perceive this
approach as creating needless documentation that detracts from the
performance of their work.
4.Interviewing
The interview method of gathering information requires that a
manager or HR specialist visit each job site and talk with the
employees performing each job. A standardized interview form is
used most often to record the information. Frequently, both the
employee and the employee’s supervisor must be interviewed to
obtain a complete understanding of the job. In some situations, such

as teamdirected jobs, group interviews also can be used, typically
involving experienced job incumbents and/or supervisors. It usually
requires the presence of a representative from the HR department as a
mediator. For certain difficult-to-define jobs, group interviews are
probably most appropriate.
The interview method can be quite time consuming, especially if the
interviewer talks with two or three employees doing each job.
Professional and managerial jobs often are more complicated to
analyze and usually require longer interviews. For these reasons,
combining the interview with one of the other methods is suggested.
5.Questionnaires
The questionnaire is a widely used method of gathering data on jobs.
A survey instrument is developed and given to employees and
managers to complete. The major advantage of the questionnaire
method is that information on a large number of jobs can be collected
inexpensively in a relatively short period of time. However, the
questionnaire method assumes that employees can accurately analyze
and communicate information about their jobs. Employees may vary
in their perceptions of the jobs, and even in their literacy. For these
reasons, the questionnaire method is usually combined with
interviews and observations to clarify and verify the questionnaire
information.
One type of questionnaire sometimes used is a checklist. Differing
from the open-ended questionnaire, the checklist offers a simplified
way for employees to give information. An obvious difficulty with the
checklist is constructing it,
which can be a complicated and detailed process
The problems that may crop up while conducting job analysis
are:
1. Lack of support from the top management.
2. Relying on one source and method of data collection.
3. Non-trained and non-motivated job holders who are the actual
source of job data.
4. Distorted information/data provided by the respondents i.e., the job
holders because of non- preparedness on their part.
Benefits of Job Analysis ↓

1. Facilitates proper publicity of jobs : Exact details of the job and
the qualifications, qualities, etc., required can be notified in the
advertisement because of job analysis. Scrutiny of applications and
selection of suitable candidates is made manageable, easy and quick.
2. Facilitates appropriate selection of psychological tests :
Psychological tests can be adjusted exactly as per the need of the job
due to the availability of details from job analysis.
3. Facilitates purposeful interviews : Interviewers should be given
the details of job analysis before interviewing the candidates. This
makes the interviews relevant as the candidates are judged accurately
in the light of details of job analysis.
4. Facilitates appropriate medical examination : Even the medical
examination is adjusted as per the information available from job
analysis.
5. Facilitates scientific selection and placement of candidates : Job
analysis makes the selection work accurate. The tragedy of misfit is
avoided. In addition, proper placement (as per qualifications and
qualities) of employees is possible due to job analysis.
6. Facilitates scientific promotions and transfers : Promotions and
transfers become easy, quick and accurate on the basis of data of job
analysis.
7. Facilitates impartial performance appraisal : A company can
make scientific and impartial performance appraisal of its employees
with the help of job analysis data.
8. Useful for providing training : Job analysis suggests the
qualities necessary for performing specific job. This information can
be used in a purposeful manner while framing training programmes
for jobs.
9. Useful for fixing wage structure : Job analysis indicates relative
worth of each job within the Organisation. This information is useful
for fixing wage rates for different categories of workers.
10. Facilitates redesigning of jobs : Job analysis gives the details of
different jobs and facilitates redesigning of jobs so as to improve
operational performance or to enrich job content and employee
improvement.

Job Description
Job description includes basic job-related data that is useful to
advertise a specific job and attract a pool of talent. It includes
information such as job title, job location, reporting to and of
employees, job summary, nature and objectives of a job, tasks and
duties to be performed, working conditions, machines, tools and
equipments to be used by a prospective worker and hazards involved
in it.
Purpose of Job Description
 The main purpose of job description is to collect job-related data
in order to advertise for a particular job. It helps in attracting,
targeting, recruiting and selecting the right candidate for the right job.
 It is done to determine what needs to be delivered in a particular
job. It clarifies what employees are supposed to do if selected for that
particular job opening.
 It gives recruiting staff a clear view what kind of candidate is
required by a particular department or division to perform a specific
task or job.
 It also clarifies who will report to whom.
Job Specification
Also known as employee specifications, a job specification is a
written statement of educational qualifications, specific qualities,
level of experience, physical, emotional, technical and
communication skills required to perform a job, responsibilities
involved in a job and other unusual sensory demands. It also includes
general health, mental health, intelligence, aptitude, memory,
judgment, leadership skills, emotional ability, adaptability, flexibility,
values and ethics, manners and creativity, etc.
Purpose of Job Specification
 Described on the basis of job description, job specification helps
candidates analyze whether are eligible to apply for a particular job
vacancy or not.
 It helps recruiting team of an organization understand what level
of qualifications, qualities and set of characteristics should be present
in a candidate to make him or her eligible for the job opening.

 Job Specification gives detailed information about any job
including job responsibilities, desired technical and physical skills,
conversational ability and much more.
 It helps in selecting the most appropriate candidate for a
particular job.
Job description and job specification are two integral parts of job
analysis. They define a job fully and guide both employer and
employee on how to go about the whole process of recruitment and
selection. Both data sets are extremely relevant for creating a right fit
between job and talent, evaluate performance and analyze training
needs and measuring the worth of a particular job.
Job Enlargement
Job enlargement is another method of job design when any
organization wishes to adopt proper job design it can opt for job
enlargement. Job enlargement involves combining various activities
at the same level in the organization and adding them to the existing
job. It increases the scope of the job. It is also called the horizontal
expansion of job activities.
Definition: Job Enlargement is the horizontal expansion of a job. It
involves the addition of tasks at the same level of skill and
responsibility. It is done to keep workers from getting bored. It is
different than job enrichment.
Examples: Small companies may not have as many opportunities for
promotions, so they try to motivate employees through job
enlargement.
Job enlargement can be explained with the help of the following
example - If Mr. A is working as an executive with a company and is
currently performing 3 activities on his job after job enlargement or
through job enlargement we add 4 more activities to the existing job
so now Mr. A performs 7 activities on the job.
It must be noted that the new activities which have been added should
belong to the same hierarchy level in the organization. By job
enlargement we provide a greater variety of activities to the individual
so that we are in a position to increase the interest of the job and make
maximum use of employee’s skill. Job enlargement is also essential
when policies like VRS are implemented in the company.

Job enlargement is doing different tasks and not just the same thing
all the time. It may involve taking on more duties and adds variety to
a person's job. Horizontal loading is often used which is giving people
more jobs to do that require the same level of skill.
Advantages of job enlargement
1. Variety of Tasks:
In job enlargement, horizontal loading of the tasks is there. Increasing
the number of tasks can reduce the level of boredom of the
employees.
2. Enlarged and Meaningful Work Modules:
Sometimes, the jobs are enlarged so that one worker completes a
whole unit of work or a major portion of it. This will increase the
satisfaction of the worker as he can see his contribution to the entire
project.
3. Optimum Utilisation of Abilities:
Enlarged jobs tend to better utilise the physical and mental skills
abilities of the workers. Enlarged jobs, with optimal levels of
complexity can create tasks, which are challenging but attainable.
4. Worker Paced Control:
In job enlargement, workers move from a machine paced production
line to a job which is paced by themselves. The workers will enjoy his
work more, if he can vary the rhythm and work at his own pace. He
will also feel less tired in this way.
5. Meaningful Feed Back:
Enlarged jobs allow for more meaningful performance feedback. It
will be even more motivating if it is tied to evaluations and
organisational rewards.
Disadvantages of Job Enlargement:
According to Herzberg merely giving a worker different kind of jobs
is not enough because the basic nature of the job remains the same,
As such it does not work as a motivating factor. Rather, there should
be upgradation of authority and responsibility.
In view of Herzberg’s opinion, the following disadvantages can be
found in job enlargement:
(i) Job enlargement tends to be a costly affair. Workers may require
additional training for their enlarged jobs. Moreover, if job

enlargement involves breaking up of existing production line of work
system and redesigning a new system and training employees for it.
the costs will be very substantial.
(ii) Productivity may fall in the short run, due to the introduction of
the new system.
(iii) Employee-unions often argue for increased pay because of the
increased work load.
(iv) Some jobs may still be routine and boring even after enlargement.
JOB ENRICHMENT
Job enrichment is a common motivational technique used by
organizations to give an employee greater satisfaction in his work. It
means giving an employee additional responsibilities previously
reserved for his manager or other higher-ranking positions. In
essence, an enriched job gives the employee more self-management in
his duties.
Purpose
Job enrichment, job rotation and job enlargement are three examples
of ways employers try to make jobs more satisfying. Whereas job
enlargement adds broader responsibilities to a position, job
enrichment gives the employee more vertical authority. The objective
is to give an employee more personal accountability for the work that
he does. By doing so, the employer hopes that he feels more of a
sense of self-worth from his role in the business
Benefits to the Company
Companies turn to job enrichment as a way of boosting the
organizational morale. The more valuable each employee feels, the
more motivated they are to produce top results. Also, companies can
operate more efficiently when employees bear significant
responsibility for their work and results. In some cases, using
enrichment can minimize layers of management. Plus, with job
enrichment, employees learn more vertical skills that equip them for a
higher level position.
Benefits to the Employee
Employees are more mentally stimulated when they take on
authoritative, decision-making roles. This keeps them mentally
focused on their tasks and the objectives of the company. Also,

ambitious employees are more likely to stick with an employer if they
are trusted to perform higher level duties. Better career opportunities
may also come as you train for new skills and learn how to work
through important workplace problems and solutions
JOB ROTATION
Job rotation involves an employee changing positions within the
same organization and eventually returning to the original position. It
can refer to different types of rotations.
Task rotation usually takes place in jobs that involve a high degree
of physical demands on the body or a high degree of repetitive tasks
that can become extremely tedious. Employees are periodically
removed from these mentally stressful or physically demanding tasks
to a less demanding task for a while to give them a break.
Let's say you work as a spot welder on a production line, where you
work 10 hour shifts four days a week. You basically spend your day
standing in place applying welds to two specific locations on the
product as it moves down the line. The production facility's
environmental controls aren't the best, and you're constantly hot and
sweating because of the protective gear you must wear along with the
heat generated by the welding machine. However, every other week
you get rotated off the line to work in the maintenance department
and tool shop, where your tasks are varied, the environment is a bit
more comfortable, and you can sit down a significant amount of the
time. This is an example of task rotation.
Position rotation is the process of laterally moving an employee to
different positions, departments or geographic locations for the
purposes of professionally developing the employee by exposing
them to new knowledge, skills and perspectives. Position rotation can
be further broken down into within-function rotation and cross-
functional rotation. Within-function rotation is where an employee
rotates between jobs with similar levels of responsibility and in the
same functional or operational areas. Cross-functional rotation, on the
other hand, usually involves a sequence of positions, often with
increasing levels of job responsibilities.
Let's say you are a junior executive at a multinational consulting firm
on the fast track. Your mentor and supervisor have just informed you

that you have been approved for the company's advance executive
training program. You will spend the next two years rotating from
your home office to the headquarters in New York, to the company's
office in London, then onto Dubai, and finally onto Hong Kong
before returning to your home office. You job responsibilities will
change a bit at each office, but you will basically still serve as a
financial analyst. Upon your return, you will receive an important
promotion so long as the rotations are successful. This is an example
of position rotation, and more specifically, within-rotation.
Advantages of Job Rotation
Task rotation has some distinct advantages. It can increase job
satisfaction because workers will be exposed to various work tasks
that will reduce constant physical or mental stress, which may create
more motivation to continue in the position and reduce turnover.
Another advantage is the ancillary effect of cross-training employees
for different tasks, which will increase the flexibility and adaptability
of the organization.
JOB DESIGN
Job design follows job analysis i.e. it is the next step after job
analysis. It aims at outlining and organising tasks, duties and
responsibilities into a single unit of work for the achievement of
certain objectives. It also outlines the methods and relationships that
are essential for the success of a certain job. In simpler terms it refers
to the what, how much, how many and the order of the tasks for a
job/s.
Job design essentially involves integrating job responsibilities or
content and certain qualifications that are required to perform the
same. It outlines the job responsibilities very clearly and also helps in
attracting the right candidates to the right job. Further it also makes
the job look interesting and specialised.
There are various steps involved in job design that follow a logical
sequence, those that were mentioned earlier on. The sequence is
as follows:
1. What tasks are required to e done or what tasks is part of the
job?
2. How are the tasks performed?

3. What amount are tasks are required to be done?
4. What is the sequence of performing these tasks?
All these questions are aimed at arriving upon a clear definition of a
specific job and thereby make it less risky for the one performing the
same. A well-defined job encourages feeling of achievement among
the employees and a sense of high self-esteem.
The whole process of job design is aimed to address various problems
within the organizational setup, those that pertain to ones description
of a job and the associated relationships. More specifically the
following areas are fine-tuned:
 Checking the work overload.
 Checking upon the work under load.
 Ensuring tasks are not repetitive in nature.
 Ensuring that employees don not remain isolated.
 Defining working hours clearly.
 Defining the work processes clearly.
The above mentioned are factors that if not taken care of result into
building stress within the employees.
Benefits of Job Design
The following are the benefits of a good job design:
1. Employee Input: A good job design enables a good job
feedback. Employees have the option to vary tasks as per their
personal and social needs, habits and circumstances in the workplace.
2. Employee Training: Training is an integral part of job design.
Contrary to the philosophy of “leave them alone’ job design lays due
emphasis on training people so that are well aware of what their job
demands and how it is to be done.
3. Work / Rest Schedules: Job design offers good work and rest
schedule by clearly defining the number of hours an individual has to
spend in his/her job.
4. Adjustments: A good job designs allows for adjustments for
physically demanding jobs by minimising the energy spent doing the
job and by aligning the manpower requirements for the same.

UNIT 2
RECRUITMENT
Meaning of Recruitment
Recruitment means to estimate the available vacancies and to make
suitable arrangements for their selection and appointment. In the
recruitment process, the available vacancies are given wide publicity
and suitable candidates are encouraged to submit applications so as to
have a pool of eligible candidates for scientific selection.
In recruitment, information is collected from interested candidates.
For this different sources of recruitment such as newspaper
advertisement, employment exchanges, internal promotions, etc.,
Definition of Recruitment
According to Edwin Flippo, "Recruitment is the process of searching
for prospective employees and stimulating them to apply for jobs in
the Organisation."
Need for Recruitment
The need for recruitment may be due to the following reasons /
situations :-
a. Vacancies : due to promotions, transfers, retirement,
termination, permanent disability, death and labour turnover.
b. Creation of new vacancies : due to growth, expansion and
diversification of business activities of an enterprise. In addition, new
vacancies are possible due to job respecification.
Factors affecting recruitment
These are broadly classified into two categories:
1. Internal Factors
2. External Factors
These are discussed one by one.
1. Internal Factors:
The internal factors also called endogenous factors are the factors
within the organisation that affect recruiting personnel in the
organisation. Some of these are mentioned here.
a. Size of the Organisation:
The size of an organisation affects the recruitment process. Experi-
ence suggests that larger organisations find recruitment less
problematic than organisations with smaller in size.

b. Recruiting Policy:
The recruiting policy of the organisation i.e., recruiting from internal
sources (from own employees) and from external sources (from
outside the organisation) also affects recruitment process. Generally,
recruiting through internal sourcing is preferred, because own em-
ployees know the organisation and they can well fit into the
organisation’s culture.
c. Image of Organisation:
Image of organisation is another internal factor having its influence
on the recruitment process of the organisation. Good image of the
organisation earned by a number of overt and covert actions by
management helps attract potential and competent candidates.
Managerial actions like good public relations, rendering public
services like building roads, public parks, hospitals and schools help
earn image or goodwill for the organisation. That is why blue chip
companies attract large number of applications.
d. Image of Job:
Just as image of organisation affects recruitment so does the image of
a job also. Better remuneration and working conditions are considered
the characteristics of good image of a job. Besides, promotion and
career development policies of organisation also attract potential
candidates.
2. External Factors:
a. Demographic Factors:
As demographic factors are intimately related to human beings, i.e.,
employees, these have profound influence on recruitment process.
Demographic factors include sex, age, literacy, economic status etc.
b. Labour Market:
Labour market conditions i.e., supply and demand of labour is of
particular importance in affecting recruitment process. For example, if
the demand for a specific skill is high relative to its supply, recruiting
employees will involve more efforts. On the contrary, if supply is
more than demand for a particular skill, recruitment will be relatively
easier.
In this context, the observation made by 11PM in regard to labour
market in India is worth citing: “The most striking feature in the

Indian Labour market is the apparent abundance of labour – yet the
‘right type’ of labour is not too easy to find”.
c. Unemployment Situation:
The rate unemployment is yet another external factor having its
influence on the recruitment process. When the unemployment rate in
a given area is high, the recruitment process tends to be simpler. The
reason is not difficult to seek. The number of applicants is expectedly
very high which makes easier to attract the best qualified applicants.
The reverse is also true. With a low rate of unemployment, recruiting
process tends to become difficult.
d. Labour Laws:
There are several labour laws and regulations passed by the Central
and State Governments that govern different types of employment.
These cover working conditions, compensation, retirement benefits,
and safety and health of employees in industrial undertakings.
Child Labour (Prohibition and Regulation) Act, 1986, for example,
prohibits employment of children in certain employments. Similarly,
several other acts such as Employment Exchange (Compulsory Noti-
fication of Vacancies) Act, 1959, the Apprentices Act, 1961; die
Factory Act, 1948 and the Mines Act, 1952 deal with recruitment.
e. Legal Considerations:
Another external factor is legal considerations with regard to employ-
ment. Reservation of jobs for the scheduled castes, scheduled tribes,
and other backward classes (OBCs) is the popular example of such
legal consideration. The Supreme Court of India has given its verdict
in favour of 50 per cent of jobs and seats. This is so in case of
admissions in the educational institutions also.
Objectives of Recruitment: Recruitment fulfills the following
objectives:
1. It reviews the list of objectives of the company and tries to achieve
them by promoting the company in the minds of public.
2. It forecasts how many people will be required in the company.
3. It enables the company to advertise itself and attract talented
people.
4. It provides different opportunities to procure human resource.

Sources of Recruitment: Recruitment is a process of searching for
prospective employees and stimulating them to apply for jobs.
Companies can adopt different methods of recruitment for selecting
people in the company. These methods are:
1. Internal sources
2. External sources
The sources can be further explained with the help of following
diagram:
Internal Sources of Recruitment: Internal sources of recruitment

refer to obtaining people for job from inside the company. There are
different methods of internal recruitment:
1. Promotion: Companies can give promotion to existing employees.
This method of recruitment saves a lot of time, money and efforts
because the company does not have to train the existing employee.
Since the employee has already worked with the company. He is
familiar with the working culture and working style. It is a method of
encouraging efficient workers.
2. Departmental examination: This method is used by government
departments to select employees for higher level posts. The
advertisement is put up on the notice board of the department. People
who are interested must send their application to the HR department
and appear for the exam. Successful candidates are given the higher
level job. The method ensures proper selection and impartiality.
3. Transfer: Many companies adopt transfer as a method of
recruitment. The idea is to select talented personnel from other

branches of the company and transfer them to branches where there is
shortage of people.
4. Retirement: Many companies call back personnel who have
already retired from the organization. This is a temporary measure.
The method is beneficial because it gives a sense of pride to the
retired when he is called back and helps the organization to reduce
recruitment selection and training cost.
5. Internal advertisement: In this method vacancies in a particular
branch are advertised in the notice board. People who are interested
are asked to apply for the job. The method helps in obtaining people
who are ready to shift to another branch of the same company and it is
also beneficial to people who want to shift to another branch.
6. Employee recommendation: In this method employees are asked
to recommend people for jobs. Since the employee is aware of the
working conditions inside the company he will suggest people who
can adjust to the situation. The company is benefited because it will
obtain.
Advantages of Internal Recruitment
1. Internal methods are time saving.
2. No separate induction program is required.
3. The method increases loyalty and reduces labour turnover.
4. This method is less expensive.
Disadvantages of Internal Recruitment
1. There is no opportunity to get new talent in this method.
2. The method involves selecting people from those available in the
company so there is limited scope for selection.
3. There are chances of biased and partiality.
4. Chances of employee discontent are very high.
External Methods/Sources of Recruitment
External sources of recruitment refer to methods of recruitment to
obtain people from outside the company. These methods are:
1. Management consultant
Management consultant helps the company by providing them with
managerial personnel, when the company is on the look out for entry
level management trainees and middle level managers. They generally
approach management consultants.

2.Employment agencies
Companies may give a contract to employment agencies that search,
interview and obtain the required number of people. The method can
be used to obtain lower level and middle level staff.
3. Campus recruitment
When companies are in search of fresh graduates or new talent they
opt for campus recruitment. Companies approach colleges,
management, technical institutes, make a presentation about the
company and the job and invite applications. Interested candidates
who have applied are made to go through a series of selection test and
interview before final selection.
4. News paper advertisement
This is one of the oldest and most popular methods of recruitment.
Advertisements for the job are given in leading news papers; the
details of the job and salary are also mentioned. Candidates are given
a contact address where their applications must be sent and are asked
to send their applications within a specified time limit. The method
has maximum reach and most preferred among all other methods of
recruitment.
5. Internet advertisement
With increasing importance to internet, companies and candidates
have started using the internet as medium of advertisement and search
for jobs. There are various job sites like naukri.com and monster.com
etc. candidates can also post their profiles on these sites. This method
is growing in popularity.
6. Walk in interview
Another method of recruitment which is gaining importance is the
walk in interview method. An advertisement about the location and
time of walk in interview is given in the news paper. Candidates
require to directly appearing for the interview and have to bring a
copy of their C.V. with them. This method is very popular among
B.P.O and call centers.
Advantages of External Recruitment
1. There is influx of new talent in the method.
2. The method encourages more and more competition.
3. There is lesser chance of partiality through this method.

4. If options like campus recruitment have been exercised we get a
chance to employ fresh graduates, thus increasing employment.
Disadvantages of External Recruitment
1. The method is costly because it involves recruitment cost,
selection, training cost.
2. The method is time consuming.
3. The method reduces loyalty to the company.
SELECTION
Meaning of Selection
Selection is next to recruitment. It is the process of choosing the most
suitable candidates (Properly qualified and competent) out of many
interested candidates. It is a process of selecting the best and rejecting
the rest. In this selection process, interested applicants are
differentiated in order to identify those with a greater likelihood of
success in a job. Such candidates are selected and appointed.
Selection is a negative function as it relates to elimination of
unsuitable candidates. 'Right man for the right job' is the basic
principle in selection. Selection of suitable candidates is a responsible
type of work as selection of unsuitable persons for jobs creates new
problems before the business unit. For appropriate selection, scientific
procedure needs to be followed.
Steps In The Scientific Selection Process
Steps involved in the selection procedure are :-
1. Job Analysis : job analysis prepares proper background for
recruitment and selection. It gives details of a job to be performed and
the human qualities and qualifications required for performing that
job efficiently. Scientific selection is possible only when it is made in
the light of the details available from job analysis. Job means an
activity performed in one or the other department of a business unit. A
job includes various positions. Clear and detailed understanding of the
job is called job analysis or job study.
2. Advertisement : This medium is widely used for recruitment of
all categories of personnel. Though quite costly, it provides a wide
choice as it attracts large number of candidates from all over the
country. The qualities and qualifications expected from the candidates
are usually mentioned in the advertisement.

3. Collection of Applications Blanks : In this step, applications
with necessary details are collected from interested candidates. Some
companies give advertisement in the press and ask interested
candidates to submit applications on a prescribed form.
4. Scrutiny of Applications Received : After the last date fixed for
the receipt of applications, officer from the personnel department
starts the scrutiny of applications received. Incomplete applications
are normally rejected. Applicants, who do not possess required
qualifications, experience, etc., are also rejected. Along with this, the
certificates, testimonials and references are checked.
5. Written Tests : After the scrutiny of applications, a final list of
candidates for written tests is prepared. The purpose of such tests is to
judge the knowledge of the candidate and also to find out his :-
a. Intelligence,
b. Aptitude,
c. Capacity,
d. Interests and
e. Suitability for a specific job.
Trade test is particularly necessary in the case of technical jobs such
as junior engineer, computer engineer and research assistant and so
on. At present, such test is given in the case of all types of jobs. For
example, written tests are used by Banks and public sector
organisations for selection purpose.
6. It is also possible to reject candidates whose performance in
such written tests is not up to the mark. Testing of candidates is a
lengthy process particularly when the number of applicants is large. In
such testing, the process of elimination can be introduced. For
example, all candidates may be invited for the first test and' the
candidates with poor performance in the first test need not be called
for the second test.
7. Psychological Tests : The psychological tests given to
candidates include the following tests :-
a. Intelligence test,
b. Aptitude test,
c. Interest test,
d. Achievement test,

e. Analytical test,
f. Performance test,
g. Synthetic test and
h. Personality test.
Each test needs to be given separately and each test is useful for
judging specific quality of a candidate to be selected for the executive
post.
8. Personal Interview : The candidates who have shown reasonably
good performance in the written examination and psychological tests
are called for personal interview. Interview technique is used
extensively for the selection of managerial posts. This interview is
conducted by one interviewer or by a group of interviewers including
top officers of the company and other professional experts. The
candidate is asked various questions about his qualifications,
experience, family background and performance in the written test
and psychological tests by the interviewers during the course of the
interview. In this final interview, an attempt is made to judge overall
personality of the candidate. The selection committee notes the plus
and minus points of every candidate and selects the best candidates
for appointment by applying certain uniform norms. Here, 'short-
listing of candidates' is done for final selection as per the need of the
organisation. The final selection depends partly on the performance of
the candidate in the tests and also on the performance in the personal
interview.
9. Reference Check : The candidate is required to give at least two
references which may be :-
a. Educational,
b. Social and
c. Employment.
These references help to cross check the information provided by the
candidate.
10. Medical Examination : The purpose of medical examination is
to judge the general health and physical fitness of the candidate.
Candidates who are not physically fit for the specific job are rejected
even when they show good performance in the tests and personal
interview. Medical test is taken in the case of all candidates before

appointment. In case of certain jobs, the test is of a general nature.
However, medical examination has special importance in armed
forces.
11. Final Selection for Appointment : The selection procedure
comes to an end when the final appointment letter is sent to the
candidate with a request to join the organisation on a particular date.
This means the 'job is offered to the selected candidate' and he is
asked to join the organisation within a specific time limit.
Psychological Tests / Selection Tests
For scientific selection of candidates (particularly for higher level /
executive level posts) different types of tests are given to candidates
as per the requirements of the post for which selection is required to
be made. Such tests include written test, trade test and psychological
tests. The basic purpose is to judge the knowledge, skills, intelligence,
aptitude, etc., of the candidate before his selection. It is also possible
to reject the candidates who show poor performance in such tests. The
possible performance of the candidate in the future can be judged with
the help of such tests. Such tests need to be conducted in a systematic
manner and not as a mere formality. The assistance of experts should
be taken while conducting such tests. In addition, the results of such
tests should be used while taking final decision regarding selection of
the candidate. Such tests are particularly useful for the selection of
supervisory staff in an Organisation.
Important Psychological Tests
1. Intelligence test : Intelligence test is useful for judging the
intelligence of a candidate. According to the industrial psychologist,
"General intelligence is the capacity of a person for comprehension
and logical reasoning." Previously only the passing certificates of
certain examinations were universally accepted as evidence of
intelligence. After long experience, employees discovered that such
certificates were not always very reliable as they indicate only paper
qualifications. Fortunately for them, two French psychologists. Simon
and Binet had developed in 1916 suitable Intelligence Tests to
measure general intelligence. According to these tests, intelligence of
a person or his intelligence quotient (I.Q.) can be measured by his
performance in the test.

2. Vocational aptitude test : Vocational aptitude has been defined
as "the capacity or latent ability of an individual to learn a job, given
the necessary training." It has been claimed that vocational aptitude is
as important and perhaps more important than general intelligence for
success on a job. It is, therefore necessary to ascertain the vocational
aptitude of a candidate before final selection.
3. Analytical test : For the purpose of analytical tests, a job is first
analyzed in terms of such qualities as speed, dexterity, observation,
etc. Terms are then devised to measure the degree to which a
candidate possesses these qualities. Dr. Munsterberg, an industrial
psychologist in the US, had first devised such tests for the selection of
telephone operators for the American Telephone and Telegraph
Company. He had also devised similar tests for the selection of
inspectors for inspection of ball bearings for an American bicycle
manufacturer. These tests had produced satisfactory results.
4. Synthetic test : In case of jobs which are complex and so cannot
be analyzed and for which analytical tests cannot be developed,
synthetic tests have been evolved. The essence of these tests is that
the candidate is presented a complex situation, more or less similar to
the one which he will have to face in his job but on a miniature scale
and he is asked to handle the situation. His performance in such a test
indicates his aptitude for the job. Dr. Munsterberg had devised such a
test for the selection of tram drivers for a Tram Company in the
United States. Today, a similar test is being used for the selection of
motor and truck drivers.
5. Trade test : Trade test is necessary and useful in the case of jobs
which involve technical work. For example, a stenographer or a typist
should be given suitable test in order to judge his ability to take
dictation or type. Similar trade tests can be given to welders, machine
operators and so on. Workers can be given such tests in order to find
out their capacities for the type of job for which they are being
considered.
6. Personality test : Personnel managers have come across many
individuals with the necessary intelligence and the vocational
aptitude, and yet did not prove successful in the jobs for which they
are selected. Industrial psychologists felt that they might not have a

suitable personality or temperament and began to develop tests to
measure personality traits. Protective test is one such test. Its essential
feature is that it induces a candidate to reveal his inner or real
personality.
Advantages Of Psychological Tests In SP
Note:- Here, SP = Selection Procedure
1. Objective comparison of candidates possible.
2. Incompetent candidates are eliminated.
3. Suitable candidates are given proper placement.
4. Right man to the right job is achieved.
5. Achievements of the candidates are verified.
6. Compatibility of the candidate can be found out.
7. Mental qualities of candidates are evaluated.
8. Overall ability of the candidates is measured.
9. Application of knowledge is found out.
10. Accuracy in selecting employees.
DIFFERENCE BETWEEN RECRUITMENT AND
SELECTION.
Basis Recruitment Selection
Meaning It is an activity of It is a process of picking

establishing contact up more competent and
between employers and suitable employees.
applicants.
Objective It encourages large number It attempts at rejecting

of Candidates for a job. unsuitable candidates.
Process It is a simple process. It is a complicated

process.
Hurdles The candidates have not to Many hurdles have to be

cross over many hurdles. crossed.
Approach It is a positive approach. It is a negative approach.

Sequence It proceeds selection. It follows recruitment.
Economy It is an economical It is an expensive

method. method.
Time Less time is required. More time is required.

Consuming
TRAINING
Meaning of Employee Training
Training is next to selection. A worker selected / appointed in an
Organisation needs proper training. This enables him to perform the
job correctly and also with efficiency. Similarly, a manager needs
training for promotion and for his self improvement. Employees are
now given training immediately after appointment and thereafter from
time to time. Training is used as a tool / technique for
management/executive development. It is used for the development of
human resource working in an Organisation. In fact, training is the
watchword of present dynamic business world.
Training means giving information, knowledge and education in order
to develop technical skills, social skills and administrative skills
among the employees. According to Edwin Flippo, training is "the act
of increasing the knowledge and skill of an employee for doing a
particular job."
Training is necessary due to technological changes rapidly taking
place in the industrial field. It is also essential along with the
introduction of new techniques, new methods and so on. It is
necessary for developing overall personality of employees and also
for developing positive attitude towards fellow employees, job and
Organisation where he is working.
Training of employees is the responsibility of the management /
employer. Expenditure on such training is an investment for
manpower development and gives good dividend in the long run.
Employees should take the benefit of training facilities provided for
raising their efficiency and also for self-development. Training need
not be treated as a punishment but an opportunity to learn, to grow
and to develop for jobs at the higher levels.
Types of Training ↓
Different types of training are :-
1. Induction training,
2. Job training,
3. Training for promotion,
4. Refresher training,
5. Training for managerial development, etc.
Induction training aims at introducing the organisation to a newly
appointed employee. It is a short and informative training given
immediately after joining the organisation. The purpose is to give
"bird's eye-view" of the organisation to an employee. Job training
relates to specific job and the purpose is to give suitable information
and guidance to a worker so as to enable him to perform the job
systematically, correctly, efficiently and finally with confidence.
Training for promotion is given after the promotion but before joining
the post at the higher level. The purpose is to enable an employee to
adjust with the work assignment at the higher level. The purpose of
refresher training is to update the professional skills, information and
experience of persons occupying important executive positions.
Training for managerial development is given to managers so as to
raise their efficiency and thereby to enable them to accept higher
positions. A company has to make provision for providing all types of
training.
Objectives of Training
1. To raise efficiency and productivity of employees and the
Organisation as a whole.
2. To create a pool of well-trained, capable and loyal employees at
all levels and thereby to make arrangement to meet the future needs of
an organisation.
3. To provide opportunities of growth and self-development to
employees and thereby to motivate them for promotion and other
monetary benefits. In addition, to give safety and security to the life
and health of employees.
4. To avoid accidents and wastages of all kinds. In addition, to
develop balanced, healthy and safety attitudes among the employees.

5. To meet the challenges posed by new developments in science
and technology.
6. To improve the quality of production and thereby to create
market demand and reputation in the business world.
7. To develop cordial labour management relations and thereby to
improve the organisational environment.
8. To develop positive attitude and behavior pattern required by an
employee to perform a job efficiently. In other words, to improve the
culture of the Organisation.
9. To prevent manpower obsolescence in an organisation.
10. To develop certain personal qualities among employees which
can serve as personal assets on long term basis.
Importance of Training ↓
(A) Benefits of Training To Employer / Management
1. Training raises the efficiency and productivity of managers. It
also improves the performance of workers due to their motivation.
2. Training improves the quality of production. It also reduces the
volume of spoiled work and wastages of all kinds. This reduces cost
of production and improves quality.
3. It reduces accidents as trained employees work systematically
and avoid mistakes in the work assigned.
4. Training reduces expenditure on supervision as trained
employees take interest in the work and need limited supervision and
control.
5. Training brings stability to labour force by reducing turnover of
managerial personnel.
6. Training raises the morale of employees.
7. Training creates skilled and efficient manpower which is an
asset of an industrial unit.
8. Training moulds attitudes of employees and develops cordial
industrial relations.
9. Training reduces absenteeism as trained managers find their job
interesting and prefer to remain present on all working days.
10. Training facilitates the introduction of new management
techniques and also new production techniques including automation
and computer technology.

11. Training creates a pool of trained and capable personnel from
which replacements can be drawn to fill up the loss of key personnel
due to retirement, etc.
12. Training provides proper guidance and instructions to newly
appointed executives and assists them to adjust properly with the job
and the organisation.
(B) Benefits of Training to Managers / Employees
1. Training creates a feeling of confidence among the employees.
It gives personal safety and security to them at the work place.
2. Training develops skills which act as valuable personal assets of
employees.
3. Training provides opportunity for quick promotion and self-
development to managers.
4. Training provides attractive remuneration and other monetary
benefits to employees.
5. Training develops adaptability among employees. It updates
their knowledge and skills and keeps them fresh. It actually refreshes
the mental outlook of employees.
6. Training develops positive attitude towards work assigned and
thereby creates interest and attraction for the job and the work place.
7. Training creates an attitude of mutual co-operation and
understanding among the managers. Such attitude is useful not only at
the work place but also in the social life.
DIFFERENCE BETWEEN TRAINING AND DEVEPMENT
Comparison Chart
BASIS OF
TRAINING DEVELOPMENT
COMPARISON
Meaning Training is a learning Development is an educational

process in which process in which the personnel of
employees get an the organization get the chance to
opportunity to develop learn the in depth application of
skill, competency and theoretical knowledge for their
knowledge as per the job overall growth.
requirement.
Term Short Term Long Term

BASIS OF
TRAINING DEVELOPMENT
COMPARISON
Focus on Present Future
Concentrated Job Career

towards
Instructor Trainer Self
Objective To improve the work To prepare employees for future

performances of the challenges.
employees.
Number of Many Only one

Individuals
Aim Specific job related Conceptual and general

knowledge
FUTURE OF TRAINING AND DEVELOPMENT
Future trends that will affect training:-
1. The use of new technologies for training delivery will increase
2. Demand for training for virtual work arrangements will rise
3. Emphasis on capture and storage and use of intellectual capital
will increase
4. Companies will rely on learning management systems,
integration with business processes, and real-time learning
5. Training will focus on business needs and performance
6. Training departments will develop partnerships and will
outsource
7. Training and development will be viewed more from a change
model perspective
NEW TECHNOLOGIES FOR TRAINING DELIVERY
 Technologies allow trainers to build into training many of the
desirable features of a learning environment
 Technology will allow training to be delivered to contingent,
decentralized employees in a timely, effective manner
PLACEMENT AND INDUCTION

After the employee is hired and oriented, he/she must be placed in
his/her right job. Placement is understood as the allocation of people
to the job. It is assignment or re-assignment of an employee to a new
or different job. Placement includes initial assignment of new
employees and promotion, transfer or demotion of present employees.
The placement is arising out of promotion, transfer, demotion.
Assignment of new employee to a job apparently seems to be simple
task. The employer advertises inviting applications from candidates
for a specific post. The advertisement contains job description and job
specifications in detail. When a candidate has selected, it is logical
that individual is placed in a position that was advertised earlier. But
the task of placement is not that simple it appears. Times are
changing. Changes in the work ethics reflecting the demand for
meaningful work. All these factors are causing organizations and
individuals to determine the placement process more closely. We are
entering the age when applicants must be considered for several jobs
rather than one. From the managerial perspective, the task is to
understand and capitalize on each person’s individually. Since, human
attributes vary along many relatively independent ability, interest,
biographical sketch and the personality dimensions, a person’s
individuality is best viewed as his/her unique profile of scores on a
variety of individual measures. Once we establish the unique profile
for each individual, people and jobs can be matched optimally within
the constraints set by available jobs and available people. If the
number of individuals is large in relation to the available jobs, only
the best qualified persons can be selected and placed. On the other
hand, when more jobs are available, optimal placement is possible.
Thus the number of people and the number of jobs determine the
placement process in any organization.
Placement Problems
The difficulty with placement is that we tend to look at the individual
but not at the job. Often, the individual does not work independent of
others. Whether the employee works independent of others or is
dependent depends on the types of jobs. Jobs in this context can be
classified into the three categories:

Σ Independent (in such activities of one worker have little bearing on
the activities of the other workers, here the placement is simple to
conduct).
Σ Sequential (activities of the workers are dependent on activities of a
fellow worker example assembly line sequential jobs).
Σ Pooled (where the job are high degree of interdependence among
activities. The final output of is the result of contribution of all
workers. It is team work which matters. Placement for this is quite
difficult).
Assessment-Classification Model and Employee Placement
1. Collect details of the employee
2. Construct his/her profile
3. Which sub-group profile to job family profile?
4. Which job family profile does subgroup profile best fit?
5. Assign the individual to job family
6. Assign the individual to specific job after further counseling and
assessment
Principles of Placement
A few basic principles should be followed at the time of placement of
a workers on the job. This is elaborated below:
1. Man should be placed on the job according to the requirements of
the job. The job should not be adjusted according to the qualifications
or requirements of the man. Job first, man next, should be the
principle of the placement.
2. The job should be offered to the person according to his
qualification. This should neither the higher nor the lower than the
qualification.
3. The employee should be made conversant with the working
conditions prevailing in the organization and all things relating to the
job. He should also be made aware of the penalties if he commits the
wrong.
4. While introducing the job to the new employees, an effort should
be made to develop a sense of loyalty and cooperation in him so that
he may realize his responsibility better towards the job and the
organization.

5. The placement should be ready before the joining date of the newly
selected person.
6. The placement in the initial period may be temporary as changes
are likely after the completion of training. The employee may be later
transferred to the job where he can do better.
Proper placement helps to improve the employees’ morale. The
capacity of the employees can be utilized fully. The right placement
also reduces labour turnover, absenteeism and also the accident rate.
Than the employee can adjust to the required environment of the
organization effectively and the performance of the employee will not
be hampered.
Problems of the Placement
The main problem of placement arises when the recruiters look at the
individuals but not the job. Often the individual does not work
independent of the others. Jobs in this context are classified into the
three categories:
1. Independent Jobs: In the independent jobs the non-overlapping
territories are allocated to each employee e.g., in the sales. In such
situations, the activities of the one employee have little bearing on the
activities of the other workers. The independent jobs do not pose great
problems in placement. Each employee has to be evaluated between
his capabilities and the interests and those required on the job. The
objective of the placement will be:
To fill the job with people who have at least the minimum required
qualifications. People should be placed on the job that will make the
best possible use of their talents, given available job or HR
constraints.
2. The dependent jobs may be sequential or pooled. In sequential jobs,
the activities of the one employee are dependent on the activities of
the fellow employee e.g., assembly lines are the best example of such
job.
3. In the pooled jobs, there is a high interdependence among the jobs.
The final output is the result of the contribution of all the workehis:
EXECUTIVE DEVELOPMENT
Executive development or management development is a systematic
process of learning and growth by which managerial personnel gain
and apply knowledge, skills, attitudes and insights to manage the
work in their organization effectively and efficiently.
According to FlIPPO “executive development includes the process by
which managers and executives acquire not only skills and
competency in their present job but also capabilities for future
managerial tasks of increasing difficulty and scope.”
Characteristics
* Executive development is a planned and organized process of
learning.
* It is an ongoing and never ending exercise.
* Executive development is a long term process as managerial skills
can not be developed overnight.
* It aims at preparing managers for managers.
OBJECTIVES OF EXECUTIVE DEVELOPMENT
* To sustain good performance of managers throughout their careers
by exploiting their full potential.
* To understand economic, technical, and institutional forces in order
to solve business problems.
* To acquire knowledge about problems of human resources.
* To think through problems which may confront the organization
now or in the future.
* To develop responsible leaders.
* To inculcate knowledge of human motivation and human
relationships.
* To increase proficiency in management techniques such as work
study, inventory control, operations research and quality control.
Process of executive development
1. Analysis of development needs: - First of all the present and future
development needs of the organization are ascertained. It is necessary
to determine how many and what type of executives are required to
meet the present and future needs of the enterprise.
2. Appraisal of the present managerial talent: - A qualitative
assessment of the existing executives is made to determine the type of
executive talent available within the organization.
3. Planning individual development programmes: Each one of us has
a unique set of physical, intellectual and emotional characteristics.

Therefore, development plan should be tailor-made for each
individual.
4. Establishing training and development programme: - The HR
department prepares comprehensive and well conceived programmes.
5. Evaluating developing programs: - Considerable money, time and
efforts are spent on executive development programmes. It is
therefore natural to find out to what extent the pregramme’s objective
has been achieved.
IMPORTANCE OF EXECUTIVE DEVELOPMENT
* Executive development programmes are required to train and
develop professional managers.
* It helps managers to develop skills to face cut throat competition.
* It enables managers to face problems related to technology and
institution.
* It helps in developing better relations with the labors.
* Executives need training and education to understand and adjust to
changes in socio-economic changes.
* Executive development is required to broader the outlook of
managers.
METHODS AND TECHNIQUES OF EXECUTIVE
DEVELOPMENT
The various techniques of executive development may be classified
into two broad categories: -
1. On the job techniques: - It consists of: -
o Coaching
o Under study
o Position rotation
o Project assignment
o Selected readings
o Multiple management
2. Off-the-job technique: - It consists of : -
o Lectures
o Case studies
o Group discussions
o Role playing

o Management games
o Sensitivity training.
COUNSELLING
MEANING OF COUNSELLING
Counselling is the service offered to the individual who is under going
a problem and needs professional help to overcome it. The problem
keeps him disturbed high strung and under tension and unless solved
his development is hampered or stunted. Counseling therefore is a
more specialized service requiring training in personality
development and handling exceptional groups of individuals.
According to Willey and Andrew Counseling involves two
individuals one skeeking help and other a professionally trained
person helped solved problems to orient and direct him to words a
goals. Which needs to his maximum development and growth?
Counseling services are there fore required for individuals having
developmental problems because of the handicap they suffer in any
area of emotional either because of hereditary factors or environment
conditions.
Generally such cases are only about five to seven percent in a
population and therefore counseling is required only for such a small
number. As compared to guidance which is for percent of individuals.
Counseling involves a lot of time for the client to unfold the problem,
gain an insight in to the complex situation.
Counseling techniques involve active listening, emphatic under
standing releasing the pent up feelings confronting the client.
Counselling is:
 The process that occurs when a client and counsellor set aside
time in order to explore difficulties which may include the stressful or
emotional feelings of the client.
 The act of helping the client to see things more clearly, possibly
from a different view-point. This can enable the client to focus on
feelings, experiences or behaviour, with a goal to facilitating positive
change.
 A relationship of trust. Confidentiality is paramount to
successful counselling. Professional counsellors will usually explain
their policy on confidentiality, they may, however, be required by law
to disclose information if they believe that there is a risk to life
Counseling Skills: Communication skills are obviously of utmost importance
to counsellors, we have lots of further pages covering these
skillsincluding: activelistening, clarification, reflection and effective questioning skills.The
counsellor will attempt to build a certain amount of rapport with their
client, but not to an extent that would allow them to become
emotionally involved.Counsellors need to be empathetic, seeing
things from the client’s point of view, rather than sympathetic (feeling
sorry for their clients). Empathy can help the counsellor to ask
appropriate questions and lead the client to positive conclusions.
Monitoring: Monitoring is the regular observation and recording of
activities taking place in a project or programme. It is a process of
routinely gathering information on all aspects of the project.To
monitor is to check on how project activities are progressing. It is
observation; ─ systematic and purposeful observation.Monitoring also
involves giving feedback about the progress of the project to the
donors, implementors and beneficiaries of the project.Reporting
enables the gathered information to be used in making decisions for
improving project performance.
Purpose of Monitoring:Monitoring is very important in project
planning and implementation. It is like watching where you are going
while riding a bicycle; you can adjust as you go along and ensure that
you are on the right track
Monitoring will be useful to:-
1. Analysing the situation in the community and its project;
2. Determining whether the inputs in the project are well utilized;
3. Identifying problems facing the community or project and
finding solutions;
4. Ensuring all activities are carried out properly by the right
people and in time;
5. Using lessons from one project experience on to another; and
6. Determining whether the way the project was planned is the
most appropriate way of solving the problem at hand.
COACHING AND MENTORING
Coaching
“A process that enables learning and development to occur and thus
performance to improve. To be a successful a Coach requires a

knowledge and understanding of process as well as the variety of
styles, skills and techniques that are appropriate to the context in
which the coaching takes place”
Mentoring
“off-line help by one person to another in making significant
transitions in knowledge, work or thinking”
Difference between Mentoring and coaching
Mentoring Coaching
Ongoing relationship that can last for a Relationship generally has a set
long period of time duration
Can be more informal and meetings Generally more structured in nature

can take place as and when the mentee and meetings are scheduled on a
needs some advice, guidance or regular basis
support
More long-term and takes a broader Short-term (sometimes time-bounded)

view of the person and focused on specific development
areas/issues
Mentor is usually more experienced Coaching is generally not performed

and qualified than the ‘mentee’. Often on the basis that the coach needs to
a senior person in the organisation have direct experience of their client’s
who can pass on knowledge, formal occupational role, unless the
experience and open doors to coaching is specific and skills-focused
otherwise out-of-reach opportunities
Focus is on career and personal Focus is generally on

development development/issues at work
Agenda is set by the mentee, with the The agenda is focused on achieving
mentor providing support and specific, immediate goals
guidance to prepare them for future
roles
Mentoring resolves more around Coaching revolves more around

developing the mentee professional specific development areas/issue
Coaching and mentoring processes
Individual and management development can take place in many
forms, some delivered by managers and some by internal or external
coaches, or mentors. Robert Dilts defines the different activities as
follows: -
Guiding: the process of directing an individual or a group along the
path leading from present state to a desired state
Coaching: helping another person to improve awareness, to set and
achieve goals in order to improve a particular behavioural
performance
Teaching: helping an individual or group develop cognitive skills and
capabilities
Mentoring: helping to shape an individual’s beliefs and values in a
positive way; often a longer term career relationship from someone
who has ‘done it before’
Counselling: helping an individual to improve performance by
resolving situations from the past.
CAREER PLANNING
Definitions:
1. A career may be defined as ‘ a sequence of jobs that constitute what
a person does for a living’.
2. According to Schermerborn, Hunt, and Osborn, ‘Career planning is
a process of systematically matching career goals and individual
capabilities with opportunities for their fulfillment’.
3. Career planning is the process of enhancing an employee’s future
value.
4. A career plan is an individual’s choice of occupation, organization
and career path.
Features of Career Planning and Career Development:
1. It is an ongoing process.
2. It helps individuals develop skills required to fulfill different career
roles.
3. It strengthens work-related activities in the organization.
4. It defines life, career, abilities, and interests of the employees.
5. It can also give professional directions, as they relate to career
goals.
Objectives of Career Planning:
The major objectives of career planning are as follows:
1. To identify positive characteristics of the employees.

2. To develop awareness about each employee’s uniqueness.
3. To respect feelings of other employees.
4. To attract talented employees to the organization.
5. To train employees towards team-building skills.
6. To create healthy ways of dealing with conflicts, emotions, and
stress.
Benefits of Career Planning:
1. Career planning ensures a constant supply of promotable
employees.
2. It helps in improving the loyalty of employees.
3. Career planning encourages an employee’s growth and
development.
4. It discourages the negative attitude of superiors who are interested
in suppressing the growth of the subordinates.
5. It ensures that senior management knows about the calibre and
capacity of the employees who can move upwards.
6. It can always create a team of employees prepared enough to meet
any contingency.
7. Career planning reduces labour turnover.
8. Every organization prepares succession planning towards which
career planning is the first step.
PROMOTION AND TRANSFERS
A promotion is the appointment of a member to another position,
within the same department or elsewhere in the
organization,involving duties and responsibilities of a more complex
or demanding nature and are recognized by a higher pay grade and
salary.
In simpler terms, promotion refers to upward movement in present job
leading to greater responsibilities, higher status and better salary.
Promotion may be temporary or permanent depending upon the
organizational requirement.
DEFINITION
According to Clothier and Spriegel,“Promotion is the transfer of an
employee to a job which pays more money or one that carries some
preferred status
Purpose and Advantages of Promotion

Promotion stimulates self-development and creates interest in the job.
According to Yoder, “promotion provides incentive to initiative,
enterprise and ambition; minimizes discontent and unrest; attracts
capable individuals; necessitates logical training for advancement and
forms an effective reward for loyalty and cooperation, long service
etc.” The purposes and advantages of promotions are to:
 recognize employee’s performance and commitment
andmotivate him towards better performance;
 develop competitive spirit among employees for acquiring
knowledge and skills for higher level jobs;
 retain skilled and talented employees;
 reduce discontent and unrest;
 To fill up job's vacant position that is created due to retirement,
resignation or demise of an employee.In this case next senior
employee will be promoted to the vacant job.
 utilize more effectively the knowledge and skills of employees;
and
 attract suitable and competent employees.
Bases of Promotion
When the promotion policy is designed, another problem arises and
that is what should be the criterion or basis for promotion seniority or
merit. Let us examine the merits and demerits of each basis.
Seniority Basis Seniority refers to length of service in the company
or in its various plants or in departments or in a particular position. If
seniority is adopted as the basis of promotion the senior most person
in the lower grade shall be promoted as and when there is any
vacancy in the higher position. The promotion will be an automatic
process i.e. a matter of course. Seniority is decided by the
organization and every employee knows his place in the promotion
list. Seniority is widely recognized as the basis of promotion in almost
all types of organizations, particularly in organization where trade
unions generally emphasize on seniority rather than merit as the basis
of promotion.
Advantages:-
(1) Measurement with these criteria is straightforward, clear, simple
and easily understandable.

(2) Seniority is in conformity with our culture in which seniority is
respected in all walks of life seniority has wide acceptability among
workers.
(3) It provides a feeling of security and assurance to employees. It
reduces uncertainties and anxieties.
(4) It reduces labour turnover. As employees become senior, their
chances of promotion also increase. This prevents them from leaving
the organization.
(5) It reduces chances of favoritism or dispute regarding promotion.
Disadvantages:-
(1) Emphasis on seniority leads to the promotion of inefficient
persons also. Oldest is not the ablest.
(2) It discourages workers to work hard or put extra efforts because
they know that it will bring them no results. It affects the morale of
meritorious workers and they leave the organisation to find better
prospects outside.
(3) Under this system, management loses control over employees. The
management can provide no incentives or punishment when
employees are sure of promotion by seniority, they disrespect
authorities.
Merit or performance—If merit is adopted as the basis of
promotion, the most able person in the lower grade, no matter he is
junior most in the company, shall be promoted. It encourages all
employees to improve their efficiency. Merit may be determined by
job- performance and by analysis of employee potential for
development through written or oral examinations or personal
interviews or their records of performance. Thus ability ignores the
value of experience. Management personnel always insist on "merit"
as the basis of promotion
Advantages:-
(1) Promotion on the basis of ability or merit encourages the efficient
workers.
(2) This system gives total weightage to efficiency and awards no
value to the length of service.
(3) Promotion on the basis of merit induces every worker to work
hard.

(4) This basis is beneficial to both—organisation and employees.
Disadvantages:-
This awards no value to the length service.
This may be misused by the management. Practice of favouritism and
nepotism are prevalent in this system.
Merit means different things to different employers and employees.
Some may treat obedience and flattery as merit while others may treat
work performance and sincerely as merit.
If there are some cases of favoritism in promotion, there will be
conflicts and general dissatisfaction among the employees.
Conclusion
From the above discussion, it is clear that neither seniority nor merit
can be sound criterion for promotion. In the interest of efficiency,
justice and for satisfaction of employees, a compromise between
seniority and merit should be worked out. Seniority should be given
due weightage but fitness i.e., merit should not be forgotten.
Promotion should, therefore, be given on the basis of merit-cum-
seniority. This will afford the employees due recognition for their
length of service while at the same time provide built- in-incentive for
better performance
TRANSFERS
Definition:
A transfer refers to lateral movement of employees within the same
grade, from one job to another. According to Flippo “a transfer is a
change in the job (accompanied by a change in the place of the job) of
an employee without a change in responsibilities or remuneration”.
Transfer differs from promotion in the sense that the latter involves a
change of job involving increase in salary, authority, status and
responsibility, while all these remain unchanged /stagnant in the case
of former. Also, transfers are frequent and regular whereas
promotions are infrequent, if not irregular.
Transfer may be initiated either by the company or the employee. In
practice, the company may transfer the employee to the place where
he/she can prove more useful and effective. Similarly, employee may
initiate transfer to a location where he/she is likely to enjoy greater
satisfaction.

Transfer could be permanent, temporary or ad hoc to meet
emergencies. Usually, permanent transfers are made due to changes in
work load or death, retirement, resignation, etc. of some employee. As
regards temporary transfer, it arises mainly due to ill health,
absenteeism, etc. of some employee.
Transfer decisions may be perceived as negative or positive
depending upon an individual’s personal preferences, needs and
aspirations. For example, an organisation may consider transfer from
Guwahati regional office to Delhi-head office as positive and reward
because it will enable the employee to broaden his/her knowledge and
work experience. On the contrary, the employee may look down upon
it as it breaks ties with his people and community in Guwahati.
Sometimes, transfers are used as an instrument for victimizing the
employees by management. Realizing it, provisions are made by
constituting labour courts to set aside transfer orders proved as
management strategy to victimize employees. In order to make
transfers useful for employee and the company, some organisations
have clear agreements with trade unions for the transfer of unionized
staff especially on promotions.
Need:
The need for making transfer is left for various reasons as listed
below:
1. To Meet Organisational Needs:
Changes in technology, volume of production, production schedule,
product line, quality of products, organisational structure, etc.
necessitate an organisation to reassign jobs among employees so that
right employee is placed on the right job.
2. To Satisfy Employee Needs:
Employees may request for transfer in order to satisfy their desire to
work in a particular department, place and under some superior.
Personal problems of employee like health, family circumstances, and
interpersonal conflicts may also necessitate transfer.
3. To Better Utilize Employee:
When an employee is not performing satisfactorily on one job and
management thinks that his/her capabilities would be utilized better
elsewhere, he/she may be transferred to other job.

4. To Make the Employee More Versatile:
In some organisations like banks, employees after working on a job
for a specified period are transferred to other job with a view to widen
their knowledge and skill and also reduce monotony. This is also
called ‘job rotation.
5. To Adjust the Workforce:
Work force can be transferred from the departments / plants where
there is less work to the departments/plants where more work is.
6. To Provide Relief:
Transfers may be made to give relief to the employees who are
overburdened or doing hazardous work for long period.
7. To Punish Employee:
Management may use transfer as an instrument to penalize employees
who are indulged in undesirable activities. As a disciplinary action,
employees are transferred to remote and far-flung areas.
Policy:
Transfer involves costs as well. Therefore, every organisation should
have a just and impartial transfer policy for its employees. Transfers
should then be affected according to such policy only. In fact, a good
and fair transfer policy serves as a guide-post to the manager in
affecting transfers as and when required in the overall interest of the
organisation.
A good transfer policy should satisfy the following requirements:
1. Specify the circumstances under which transfers will be made.
These should be in writing and should be communicated to the
employees. For example, defence personnel and government
employees are subjected to transfer once in three years. The
employees in these organisations know when they are due for a
transfer and are prepared for it.
2. Specify the basis for transfer i.e., whether transfer will be made on
the basis of seniority or skill and competency or on any other basis.
3. Decide the authority which would handle transfers.
4. Intimate the fact of transfer to the person concerned well in
advance.
5. Specify the jobs to which transfers will be made and duties and
salary on assumption of new jobs should also be clarified.

6. Clarify whether transfer is permanent or temporary.
7. Indicate whether transfers can be made within a department or
between departments or between units.
8. Not to be made frequent and not for the sake of transfer only.
However, one should not expect for a uniform transfer policy in all
the organisations. Depending on the type, kind and size of the
organisation, transfer policy is subject to vary from organisation to
organisation. In any case, a good transfer policy should be consistent
with the overall objectives of the organisation.
Types:
Employee transfers may be classified into following types:
1. Production Transfer:
Such transfers are made when labour requirements in one division or
branch is declining. The surplus employees from such division are
transferred to those divisions or branches where there is shortage of
employees. Such transfers help avoid lay off and stabilize
employment.
2. Remedial Transfer:
Such transfers are affected to correct the wrong selection and
placement of employees. A wrongly placed employee is transferred to
more suitable job. Such transfers protect the interest of the employee.
3. Replacement Transfer:
Replacement transfers are similar to production transfers in their
inherent, i.e. to avoid layoffs. Replacement transfers are affected
when labour requirements are declining and are designed to replace a
new employee by an employee who has been in the organisation for a
sufficiently long time. The purpose of these transfers is to retain long
service employees in the organisation and also give them some relief
from the heavy pressure of work.
4. Versatility Transfer:
These transfers are also known as ‘job rotation? In such transfers,
employees are made move from one job to another to gain varied and
broader experience of work. It benefits both the employee and
organisation. It reduces boredom and monotony and gives job
enrichment to the employee. Also, employees’ versatility can be
utilized by the organisation as and when needed.

5. Shift Transfers:
These transfers are affected in the organisations where work
progresses for 24 hours or in shifts. Employees are transferred from
one shift to another usually on the basis of mutual understanding and
convenience.
6. Penalty Transfer:
Management may use transfer as an instrument to penalize
employees’ involved in undesirable activities in the organisation.
Employee transfer from one’s place of convenience to a far-flung and
remote area is considered as a penalty to the employee.
DEMOTIONS
Demotion is a process by which the employee is downgraded and sent
to a lower position from the one he is holding at present. When an
employee is moved to a job with less responsibility, status or
compensation he is said to be demoted. Demotion is the reverse of
promotion. It is more a punishment for inefficiency or incompetence.
According to D.S Beach, Demotion is “the assignment of an
individual to a job of lower rank and pay usually involving lower
level of difficulty and responsibility”. According to ArunMonappa
and Saiyadain Demotion “is a downward assignment in the
organization’s hierarchy to a lower level job which has less
responsibility, pay and status. Because of this hierarchical
repositioning it has a negative connotation and may lead to employee
dissatisfaction”. Demotions, being a serious penalty, must be handled
tactfully. The usefulness of demotion as a punitive measure is
questioned on many grounds. A demoted employee will be
disgruntled and his dissatisfaction may spread to co-workers which
will adversely affect morale, productivity and discipline of the
workforce. Causes of Demotion
1. Demotion may be used as a disciplinary weapon
2. Demotion may be resorted to when employees, because of ill
health or personal reasons, cannot do their job properly
3. If a company curtails some of its activities, employees are often
required to accept lower-level position until normally is restored.

4. If an employee finds it difficult to meet job requirement
standards, following his promotion he may be reverted to his old
position.
Conditions for demotions:-
Violations of rules and regulations of the organization would subject
an employee to demotion. Here it should be noted that serious
violations if rules and regulations would only warrant such a drastic
action. Demotion should never be made as penalty for violation of the
rules of conduct, poor attendance record or insubordination.
There should be a proper and detailed investigation of any alleged
violation of rules and regulation
If any violations occur, there should be a consistent and equitable
application of the penalty. A hasty decision should be avoided.
There must be a provision for review.
Demotions have a serious impact on the employees. Therefore,
demotions are made infrequently
Separations:-
Separation means cessation of service of agreement with the
organization. Separation can be the result of: (a) Resignation (b)
Discharge (c) Dismissal (d) Retrenchment (e) Lay-off (f) Golden
handshake (g) Retirement
(a) Resignation A resignation is a voluntary separation. When a
termination is initiated by the employee himself, it is termed a
resignation. Resignations may be put in voluntarily by the employees
on grounds of marriage especially in case of young girls, health,
physical disability, better opportunities elsewhere, or maladjustment
with company policy and affairs. The personnel department should
investigate the real reasons behind such resignations. A study of exit
interviews over a period of time may disclose a fiscal pattern
suggesting improvements in the personnel management functions.
Resignation may also be compulsory when an employee is asked to
put in his papers if he wants to avoid termination of services on the
ground of gross negligence of duty or some serious charge against
him.
(b) Discharge A discharge involves permanent separation of an
employee from the organization because of poor performance,

violation of rules or poor code of conduct. A discharge becomes
necessary when (i) The business volume is reduced thereby reducing
the employment opportunities in the organization, (ii) The employee
fails to work according to the requirements of the job, or (iii) The
employee forfeits his right to a job. Discharges are generally made in
accordance with the standing orders. The action taken should be
bonafide and nor a punitive measure or a case of victimisation.
(c) Dismissal When the termination is initiated by the organization, it
is termed as dismissal. A dismissal is the termination of the services
of an employee by way of punishment for some misconduct, or for
prolonged absence from duty. A dismissal is a drastic step. Therefore,
it must be supported with a just and sufficient cause. It is generally
done as a last resort after all attempts at reconciliation have failed.
Before an employee’s services are terminated, he should be given an
opportunity to explain his conduct and show cause why he should not
be dismissed. The principle of natural justice should be followed to
ensure that the punishment is in proportion to the offence. As a
safeguard, responsibility for dismissal should not rest on the
immediate supervisor. The approval of the next higher authority
should generally be taken and the personnel manager should be
consulted. Dismissals can be on the ground of unsatisfactory
performance, misconduct, or want of qualifications for the job, or
excessive absenteeism. Promotions, Demotions, Transfers,
Separation, Absenteeism and Turnover NOTES Self-Instructional
Material 125
(d) Retrenchment Retrenchment is termination of service due to
redundancy. It is a permanent termination of the services of an
employee for economic reasons in a going concern. It must be noted
that termination of services as a punishment given by way of
disciplinary action or superannuation or continued ill health does not
constitute retrenchment. The term retrenchment is applied to
continuing operations where a part of the workforce is found to be
superfluous. Retrenchment has many unstabilising effects. It
influences the attitudes and contributions of other employees who
become disturbed by rumours, gossips, resentment and a sense of
insecurity about their own fate. The principle in the procedure of

retrenchment is that the last person employed in each category must
be the first person to be retrenched. For this purpose, the employer
prepares a list of all the workers in the category where retrenchment is
contemplated, arranged according to the seniority of service of the
employees in that category. When vacancies arise after retrenchment,
the organization gives an opportunity to the retrenched workers to
offer themselves for re-employment; and they are given preference.
(e) Layoff According to Section 2 (KKK) of the Industrial Disputes
Act, a layoff is “the failure, refusal or inability of an employer, on
account of shortage of coal power or raw materials, or the
accumulations of stocks or breakdown of machinery for any reason, to
give employment to a workman whose name is borne on the muster
roll of his individual establishment and who has not been retrenched”.
According to this definition, a lay off refers to an indefinite separation
of the employee from the pay roll due to factors beyond the control of
the employer. The employee is expected to be called back in the
forseeable future. The laid-off employee is not a discharged employee
and is still carried on the roll as an employee.
Layoff is resorted to by the employer for factors beyond his control.
Such factors could be::-
Fluctuations in the market resulting in loss of sales
Shortage of raw materials or power.
Accumulation of stock.
 Breakdown of machinery
. Production delays

UNIT 3
PERFORMANCE APPRAISAL
Meaning of Performance Appraisals
Performance Appraisals is the assessment of individual’s performance
in a systematic way. It is a developmental tool used for all round
development of the employee and the organization. The performance
is measured against such factors as job knowledge, quality and
quantity of output, initiative, leadership abilities, supervision,
dependability, co-operation, judgment, versatility and health.
Assessment should be confined to past as well as potential
performance also. The second definition is more focused on behaviors
as a part of assessment because behaviors do affect job results.
Performance Appraisals and Job Analysis Relationship
Job Analysis à Performance Performance
Standards à Appraisals
Describe the work Translate job Describe the job
and personnel requirements into relevant strengths
requirement of a levels of acceptable and weaknesses of
particular job. or unacceptable each individual.
performance
Objectives of Performance Appraisals
Performance Appraisal can be done with following objectives in
mind:
1. To maintain records in order to determine compensation
packages, wage structure, salaries raises, etc.
2. To identify the strengths and weaknesses of employees to place
right men on right job.
3. To maintain and assess the potential present in a person for
further growth and development.
4. To provide a feedback to employees regarding their
performance and related status.
5. To provide a feedback to employees regarding their
performance and related status.
6. It serves as a basis for influencing working habits of the
employees.
7. To review and retain the promotional and other training
programmes.
Advantages of Performance Appraisal
It is said that performance appraisal is an investment for the company
which can be justified by following advantages:
1. Promotion: Performance Appraisal helps the supervisors to
chalk out the promotion programmes for efficient employees. In this
regards, inefficient workers can be dismissed or demoted in case.
2. Compensation: Performance Appraisal helps in chalking out
compensation packages for employees. Merit rating is possible
through performance appraisal. Performance Appraisal tries to give
worth to a performance. Compensation packages which includes
bonus, high salary rates, extra benefits, allowances and pre-requisites
are dependent on performance appraisal. The criteria should be merit
rather than seniority.
3. Employees Development: The systematic procedure of
performance appraisal helps the supervisors to frame training policies
and programmes. It helps to analyse strengths and weaknesses of
employees so that new jobs can be designed for efficient employees.
It also helps in framing future development programmes.
4. Selection Validation: Performance Appraisal helps the
supervisors to understand the validity and importance of the selection
procedure. The supervisors come to know the validity and thereby the
strengths and weaknesses of selection procedure. Future changes in
selection methods can be made in this regard.
5. Communication: For an organization, effective communication
between employees and employers is very important. Through
performance appraisal, communication can be sought for in the
following ways:
a. Through performance appraisal, the employers can
understand and accept skills of subordinates.
b. The subordinates can also understand and create a trust
and confidence in superiors.
c. It also helps in maintaining cordial and congenial labour
management relationship.

d. It develops the spirit of work and boosts the morale of
employees.
All the above factors ensure effective communication.
6. Motivation: Performance appraisal serves as a motivation tool.
Through evaluating performance of employees, a person’s efficiency
can be determined if the targets are achieved. This very well
motivates a person for better job and helps him to improve his
performance in the future.
Goals of Performance Appraisals
General Goals Specific Goals
Developmental Use Individual needs
Performance feedback
Transfers and Placements
Strengths and Development needs
Administrative Salary
Decisions / Uses Promotion
Retention / Termination
Recognition
Lay offs
Poor Performers identification
Organizational HR Planning
Maintenance Training Needs
Organizational Goal achievements
Goal Identification
HR Systems Evaluation
Reinforcement of organizational needs
Documentation Validation Research
For HR Decisions
Legal Requirements
Performance Appraisal Process
1. Establish Performance Standards:
The appraisal process begins with the establishment of performance
standards. The managers must determine what outputs,
accomplishments and skills will be evaluated. These standards should
have evolved out of job analysis and job descriptions.
These performance standards should also be clear and objective to be
understood and measured. Standards should not be expressed in an
articulated or vague manner such as “a good job” or “a full day’s
work” as these vague phrases tells nothing.
2. Communicate Performance Expectations to Employees:
Once the performance standards are established, this need to be
communicated to the respective employees so that they come to know
what is expected of them. Past experience indicates that not
communicating standards to the employees compounds the appraisal
problem.
Here, it must be noted that mere transference of information (relating
to performance standards, for example) from the manager to the
employees is not communication It becomes communication only
when the transference of information has taken place and has been
received and understood by the employees’.
The feedback from the employees on the standards communicated to
them must be obtained. If required, the standards may be modified or
revised in the light of feedback obtained from the employees. It is
important to note that communication is a two-way street.
3. Measure Actual Performance:
This is the third step involved in the appraisal process. In this stage,
the actual performance of the employee is measured on the basis of
information available from various sources such as personal
observation, statistical reports, oral reports, and written reports.
Needless to mention, the evaluator’s feelings should not influence the
performance measurement of the employee. Measurement must be
objective based on facts and findings. This is because what we
measure is more critical and important to the evaluation process than
how we measure.
4. Compare Actual Performance with Standards:
In this stage, the actual performance is compared with the
predetermined standards. Such a comparison may reveal the deviation
between standard performance and actual performance and will
enable the evaluator to proceed to the fifth step in the process, i.e., the
discussion of the appraisal with the concerned employees.

5. Discuss the Appraisal with the Employee:
The fifth step in the appraisal process is to communicate to and
discuss with the employees the results of the appraisal. This is, in fact,
one of the most challenging tasks the manager’s face to present an
accurate appraisal to the employees and then make them accept the
appraisal in a constructive manner.
A discussion on appraisal enables employees to know their strengths
and weaknesses. This has, in turn, impact on their future performance.
Yes, the impact may be positive or negative depending upon how the
appraisal is presented and discussed with the employees.
6. Initiate Corrective Action:
The final step in the appraisal process is the initiation of corrective
action when it is necessary. The areas needing improvement are
identified and then, the measures to correct or improve the
performance are identified and initiated.
The corrective action can be of two types. One is immediate and deals
predominantly with symptoms. This action is often called as “putting
out fires.” The other is basic and delves into causes of deviations and
seeks to adjust the difference permanently.
This type of action involves time to analyse deviations. Hence,
managers often opt for the immediate action, or say, “put out fires”.
Training, coaching, counselling, etc. is the common examples of
corrective actions that managers initiate to improve the employee
performance.
Difference between Traditional and Modern (Systems) approach to
Appraisals
Categories Traditional Appraisals Modern, Systems
Appraisals
Guiding Values Individualistic, Control Systematic,
oriented, Documentary Developmental,
Problem solving
Leadership Styles Directional, Evaluative Facilitative, Coaching
Frequency Occasional Frequent
Formalities High Low
Rewards Individualistic Grouped,
Organizational

TECHNIQUES / METHODS OF PERFORMANCE APPRAISALS
Numerous methods have been devised to measure the quantity and
quality of performance appraisals. Each of the methods is effective for
some purposes for some organizations only. None should be
dismissed or accepted as appropriate except as they relate to the
particular needs of the organization or an employee.
Broadly all methods of appraisals can be divided into two different
categories.
 Past Oriented Methods
 Future Oriented Methods
Past Oriented Methods
1. Rating Scales: Rating scales consists of several numerical scales
representing job related performance criterions such as dependability,
initiative, output, attendance, attitude etc. Each scales ranges from
excellent to poor. The total numerical scores are computed and final
conclusions are derived. Advantages – Adaptability, easy to use, low
cost, every type of job can be evaluated, large number of employees
covered, no formal training required. Disadvantages – Rater’s biases
2. Checklist: Under this method, checklist of statements of traits of
employee in the form of Yes or No based questions is prepared. Here
the rater only does the reporting or checking and HR department does
the actual evaluation. Advantages – economy, ease of administration,
limited training required, standardization. Disadvantages – Raters
biases, use of improper weighs by HR, does not allow rater to give
relative ratings
3. Forced Choice Method: The series of statements arranged in the
blocks of two or more are given and the rater indicates which
statement is true or false. The rater is forced to make a choice. HR
department does actual assessment. Advantages – Absence of
personal biases because of forced choice. Disadvantages – Statements
may be wrongly framed.
4. Forced Distribution Method: here employees are clustered
around a high point on a rating scale. Rater is compelled to distribute
the employees on all points on the scale. It is assumed that the
performance is conformed to normal distribution. Advantages –

Eliminates Disadvantages – Assumption of normal distribution,
unrealistic, errors of central tendency.
5. Critical Incidents Method: The approach is focused on certain
critical behaviors of employee that makes all the difference in the
performance. Supervisors as and when they occur record such
incidents. Advantages – Evaluations are based on actual job
behaviors, ratings are supported by descriptions, feedback is easy,
reduces recency biases, chances of subordinate improvement are high.
Disadvantages – Negative incidents can be prioritized, forgetting
incidents, overly close supervision; feedback may be too much and
may appear to be punishment.
6. Behaviorally Anchored Rating Scales: statements of effective
and ineffective behaviors determine the points. They are said to be
behaviorally anchored. The rater is supposed to say, which behavior
describes the employee performance. Advantages – helps overcome
rating errors. Disadvantages – Suffers from distortions inherent in
most rating techniques.
7. Field Review Method: This is an appraisal done by someone
outside employees’ own department usually from corporate or HR
department. Advantages – Useful for managerial level promotions,
when comparable information is needed, Disadvantages – Outsider is
generally not familiar with employees work environment,
Observation of actual behaviors not possible.
8. Performance Tests & Observations: This is based on the test of
knowledge or skills. The tests may be written or an actual
presentation of skills. Tests must be reliable and validated to be
useful. Advantage – Tests may be apt to measure potential more than
actual performance. Disadvantages – Tests may suffer if costs of test
development or administration are high.
9. Confidential Records: Mostly used by government departments,
however its application in industry is not ruled out. Here the report is
given in the form of Annual Confidentiality Report (ACR) and may
record ratings with respect to following items; attendance, self
expression, team work, leadership, initiative, technical ability,
reasoning ability, originality and resourcefulness etc. The system is
highly secretive and confidential. Feedback to the assessee is given

only in case of an adverse entry. Disadvantage is that it is highly
subjective and ratings can be manipulated because the evaluations are
linked to HR actions like promotions etc.
10. Essay Method: In this method the rater writes down the
employee description in detail within a number of broad categories
like, overall impression of performance, promoteability of employee,
existing capabilities and qualifications of performing jobs, strengths
and weaknesses and training needs of the employee. Advantage – It is
extremely useful in filing information gaps about the employees that
often occur in a better-structured checklist.
Disadvantages
It its highly dependent upon the writing skills of rater and most of
them are not good writers. They may get confused success depends on
the memory power of raters.
11. Cost Accounting Method: Here performance is evaluated from
the monetary returns yields to his or her organization. Cost to keep
employee, and benefit the organization derives is ascertained. Hence
it is more dependent upon cost and benefit analysis.
12. Comparative Evaluation Method (Ranking & Paired
Comparisons): These are collection of different methods that
compare performance with that of other co-workers. The usual
techniques used may be ranking methods and paired comparison
method.
 Ranking Methods: Superior ranks his worker based on merit,
from best to worst. However how best and why best are not
elaborated in this method. It is easy to administer and explanation.
 Paired Comparison Methods: In this method each employee is
rated with another employee in the form of pairs. The number of
comparisons may be calculated with the help of a formula as under.
N x (N-1) / 2
Future Oriented Methods
1. Management By Objectives: It means management by
objectives and the performance is rated against the achievement of
objectives stated by the management. MBO process goes as under.
 Establish goals and desired outcomes for each subordinate
 Setting performance standards

 Comparison of actual goals with goals attained by the employee
 Establish new goals and new strategies for goals not achieved in
previous year.
Advantage – It is more useful for managerial positions.
Disadvantages – Not applicable to all jobs, allocation of merit pay
may result in setting short-term goals rather than important and long-
term goals etc.
2. Psychological Appraisals: These appraisals are more directed to
assess employees potential for future performance rather than the past
one. It is done in the form of in-depth interviews, psychological tests,
and discussion with supervisors and review of other evaluations. It is
more focused on employees emotional, intellectual, and motivational
and other personal characteristics affecting his performance. This
approach is slow and costly and may be useful for bright young
members who may have considerable potential. However quality of
these appraisals largely depend upon the skills of psychologists who
perform the evaluation.
3. Assessment Centers: This technique was first developed in USA
and UK in 1943. An assessment center is a central location where
managers may come together to have their participation in job related
exercises evaluated by trained observers. It is more focused on
observation of behaviors across a series of select exercises or work
samples. Assessees are requested to participate in in-basket exercises,
work groups, computer simulations, role playing and other similar
activities which require same attributes for successful performance in
actual job. The characteristics assessed in assessment center can be
assertiveness, persuasive ability, communicating ability, planning and
organizational ability, self confidence, resistance to stress, energy
level, decision making, sensitivity to feelings, administrative ability,
creativity and mental alertness etc. Disadvantages – Costs of
employees traveling and lodging, psychologists, ratings strongly
influenced by assessee’s inter-personal skills. Solid performers may
feel suffocated in simulated situations. Those who are not selected for
this also may get affected.
Advantages – well-conducted assessment center can achieve better
forecasts of future performance and progress than other methods of

appraisals. Also reliability, content validity and predictive ability are
said to be high in assessment centers. The tests also make sure that the
wrong people are not hired or promoted. Finally it clearly defines the
criteria for selection and promotion.
4. 360-Degree Feedback: It is a technique which is systematic
collection of performance data on an individual group, derived from a
number of stakeholders like immediate supervisors, team members,
customers, peers and self. In fact anyone who has useful information
on how an employee does a job may be one of the appraisers. This
technique is highly useful in terms of broader perspective, greater
self-development and multi-source feedback is useful. 360-degree
appraisals are useful to measure inter-personal skills, customer
satisfaction and team building skills. However on the negative side,
receiving feedback from multiple sources can be intimidating,
threatening etc. Multiple raters may be less adept at providing
balanced and objective feedback.
WAGE AND SALARY ADMINISTERATION
Wage and Salary Administration’ refers to the establishment and
implementation of sound policies and practices of employee
compensation. The basic purpose of wage an*d salary administration
is to establish and maintain an equitable wage and salary structure.
Wages and salaries are often one of the largest components of cost of
production and such have serious implications for growth and
profitability of the company. On the other hand, they are the only
source of workers’ income. Wage is the remuneration paid by the
employer to an employee.
FACTORS AFFECTING WAGES
(i) Labour Unions:

The labour unions attempt to work and influence the wages primarily
by regulating or affecting the supply of labour. The unions exert their
influence for a higher wage and allowances through collective
bargaining with the representatives of the management.
If they fail in their attempt to raise the wage and other allowances
through collective bargaining, they resort to strike and other methods
where by the supply of labour is restricted. This exerts a kind of

influence on the employees to concerned test partially the demands of
the labour unions.
(ii) Personal perception of wage:
Whether the wage is adequate and equitable depends not only upon
the amount that is paid but also upon the perceptions and the views of
the recipients of the wage. Even though the wage is above the going
wage rate in the community if it is lower than that of fellow worker
deemed inferior, it will be regarded as inequitable in the eyes of the
recipients of the wage. A man’s perception of the equity of his wage
will undoubtedly affect his behaviour in joining and continuing in the
organisation.
(iii) Cost of living:
Another important factor affecting the wage is the cost of living
adjustments of wages. This approach tends to vary money wage
depending upon the variations in the cost of living index following
rise or fall in the general price level and consumer price index. It is an
essential ingredient of long term labour contracts unless provision is
made to reopen the wage clause periodically.
There are measurement problems both in ascertaining productivity
and cost of living increases. This problem may lead to lack of
understanding and unanimity on the part of the management and the
workers.
(iv) Government legislation:
The laws passed and the labour policies formed by the Government
have an important influence on wages and salaries paid by the
employees. Wages and salaries can’t be fixed below the level
prescribed by the government. The laws on minimum wages, hours of
work, equal pay for equal work, payment of dearness and other
allowances, payment of bonus, etc. have been enacted and enforced to
bring about a measure of fairness in compensating the working class.
(v) Ability to pay:
Labour unions have often demanded an increase in wages on the basis
that the firm is prosperous and able to pay. However, the fundamental
determinants of the wage rate for the individual firm emanate for
supply and demand. If the firm is marginal and cannot afford to pay
competitive rates, its employees will generally leave it for better

paying jobs. However, this adjustment is neither immediate nor
perfect because of problems of labour immobility and lack of perfect
knowledge of alternatives. If the firm is highly successful, there is
little need to pay for more than the competitive rates to obtain
personnel.
(vi) Supply and demand:
As stated earlier, the wage is a price for the services rendered by a
worker or employee. The firm desires these services, and it must pay
a price that will bring forth the supply, which is controlled by the
individual worker or by a group of workers acting together through
their unions. The practical result of the operation of this law of supply
and demand is the creation of “going- wage rate”.
It is not practicable to draw demand and supply curves for each job in
an organisation even though, theoretically, a separate curve exists for
each job. But, in general, if anything works to decrease the supply of
labour such as restriction by a particular labour union, there will be a
tendency to increase the wage. The reverse of each situation is likely
to result in a decrease in employee wage, provided other factors, such
is those discussed below, do not intervene.
(vii) Productivity:
Increasingly there is a trend towards gearing wage increases to
productivity increases. Productivity is the key factor in the operations
of a company. High wages and low costs are possible only when
productivity increases appreciably. The above factors exercise a kind
of general influence on wage rates. In addition, there are several
factors which do affect the individual difference in wage rates.
METHODS OF WAGE PAYMENT
1. Time wages
2. Piece wage
3. Incentive wage
1.Time Wage System:
This is the oldest method of wage payment. “Time” is made a basis
for determining wages of worker. Under this system, the wages are
paid according to the time spent by workers irrespective of his output
of work done. The wage rates are fixed for an hour, a day, week, a
month or even a year (seldom used).

For example, a wage rate of Rs. 70 per day is fixed in an industrial
unit. Two workers A and B attend work for 28 and 16 days
respectively. The wages as per time wage system will be Rs. 1960 and
1120 for A and B respectively. This method of wage payment does
not give weight age to the quantity of goods produced by the workers.
The supervisor may ensure that workers do not waste their time and
the quality of goods is also maintained. There are no hard and fast
rules for fixing rates of wages. These may be decided according to the
level of the past higher positions may be paid higher rates and vice-
versa.
Wages are calculated in the method as follows:
Earnings = T x R where T stands for time spent and R is rate of pay.
Suitability:
Time wage system is suitable under following situations:
(1) When productivity of an employee cannot be measured precisely.
(2) Where quality of products is more important than the quantity
produced.
(3) Where individual employees do not have any control over
production.
(4) Where close supervision of work is possible.
(5) Where work delays are frequent and beyond the control of
workers.
Advantages:
1. Simplicity:
The method of wage payments is very simple. The workers will not
find any difficulty in calculating the wages. The time spent by a
person multiplied by the rate will determine his wages.
2. Security:
Workers are guaranteed minimum wages for the time spent by them.
There is no link between wages and output, wages are paid
irrespective of output. They are not supposed to complete particular
task for getting their wages. They are sure to set certain wages at the
end of a specified period of time spent in working.
3. Batter Quality of Products:
When workers are assured of wages on time basis, they will improve
the quality of products. If wages are related to output, then workers

may think of increasing production without bothering about quality of
goods.
In this method, workers will concentrate on producing better quality
of goods. In certain situations, only time wage system will be suitable.
If some artistic nature products are produced, then this method will be
most suitable.
4. Support of Unions:
This method is acceptable to trade unions because it does not
distinguish between workers on the basis of their performance. Any
method which gives different wage rates or wages based on output is
generally opposed by trade unions.
5. Beneficial for Beginners:
Wage rate system is good for the beginners because they may not be
able to reach particular level of production on entering employment.
6. Less, Wastages:
The workers will not be in a hurry to push through production. The
materials and equipment’s will be properly handled leading to less
wastage.
Limitations:
Time wage system suffers form the following drawbacks:
1. No Incentive for efficiency:
This method does not distinguish between efficient and inefficient
workers. The payment of wages is related to time and not output.
Thus, the method gives no incentive for more production.
Efficient workers may start to follow inefficient persons because rates
of pay are same. Rates of wages fixed in this method are also low
because these are fixed by taken into account the output of dullest
workers. Thus, this method does not provide incentive for efficiency.
2. Wastage of time:
Workers may waste their time because they will not be following a
target of production. Efficient workers may also follow slow workers
because there is no distinction between them. This may lead to
wastage of time.
3. Low production:
Since wages are not related to output, production rate shall be low.
The responsibility for increasing production may mostly lie on

supervisors. Because of low production, overhead expenses per unit
will go up, leading to higher production cost.
4. Difficulty to determine labour cost:
Because wages are not related to output, employees find it difficult to
calculate labour cost per unit. The output will go on varying from
time to time while wages will remain almost same. Production
planning and control will be difficult in the absence of a relationship
between wages and output wages and output.
5. Difficult supervision work:
Under this system, workers are not offered incentives for production.
To get more worker from them, there will be need for greater
supervision. More supervision may be required to maintain proper
quality of goods also. In wage system supervision cost goes up to a
great extent.
6. Employer-employee trouble:
When all employees, irrespective of their merit are treated equally,
there is likely to be a trouble between management and workers.
Those employees, who are not satisfied with this method, may start
disobeying order from their superiors
2.PIECE WAGE
piece system of payment, wages are based on output and not on time.
There is no consideration for time taken in completing a task. A fixed
rate is paid for each unit produced, job completed or an operation
performed. Workers are not guaranteed minimum wages under this
system of wage payment.
The wages to be paid to a worker can be calculated as follows:
Quantity produced = output x piece rate
The quantity produced by a worker will be multiplied by the rate per
unit for calculating wages. An equitable piece rate should be fixed for
giving incentive to the workers for producing more. Different piece
rates will be determined for separate jobs. The factors like efforts
involved, conditions under which work is to be performed, risk
involved, etc. should also be taken into consideration while fixing
piece rates.

The piece rate should be reviewed from time to time. These should be
linked to price index so that workers are able to get a minimum level
of real wages. Piece rates should also be revised when competitors do
so otherwise there may be a discontentment among workers and they
may opt for changing in the unit/enterprise.
Advantages:
The piece rate system has the following advantages:
1. Wages linked to efforts:
Under piece wage system, wages are linked to the output of a worker.
The higher the output, higher will be the wages. Workers will try to
put in more and more effort for increasing output because their wages
will go up.
2. Increase in production:
Production goes up when wages are paid according to piece rate
system. Workers will feel encouraged to increase output because their
wages will also increase. This system is fair to both employees and
employers. Efficient workers will try to exert maximum in order to
raise their production and hence wages.
3. Better utilization of equipment/machines:
The machines and other equipment’s are put to maximum utilization.
Workers may not like to keep the machines idle. The use of machines
will also be systematic because any breakdown in these may affect the
workers adversely. Thus, better machine utilization will give better
output.
4. Distinction between Efficient and Inefficient:
As in time wages system, efficient and in efficient workers are not
given equal treatment in the piece wage system. Efficient workers will
get more because of their better results. Inefficient workers on the
other hand will get less because of low production. This method
provides sufficient encouragement to efficient workers or showing
better results.
5. Less supervision required:
Since payments are on the basis of output, workers will not waste
time. They will continue to work irrespective of supervision. There
may be more and more voluntary efforts on the part of workers and
need for supervision is reduced to a minimum.

6. Effective cost control:
The increase in output will result in reduction of overhead expenses
per unit. Some of the overhead expenses being fixed, increase in
production will reduce expenses per unit. Reduction in cost may
benefit consumers in the form of decrease in product price.
7. Better planning and control:
The certainty in achieving production targets will improve planning
and control. When management is sure of certain quantity of
production, then it can plan other things with more confidence, it will
also ensure better control over production because targets may be
regularly reviewed from time to time. Thus, better planning and
control is possible.
Limitations:
1. No guarantee or minimum wage:
There is a direct relationship between output and wages. If a worker
does not ensure certain productions, then wages may also be
uncertain. Any type of interruption in work may reduce earnings of
workers. So workers are not sure about getting minimum wages. So
this system does not provide guarantee of minimum wages.
2. Poor quality of goods/products:
The workers will bother more about the number of units otherwise
more supervisors are appointed to keep watch on quality of products
being produced.
3. Not suitable for beginners:
The beginners will not be able to produce more goods because of less
experience. They will earn much low wages as compared to
experienced workers because their rate of production will be low.
Thus, this system is not suitable for beginners.
4. Deterioration in health:
Workers may try to work more than their capacity. This may
adversely affect their health. They may try to work even when they
are not keeping good health, since wages are linked with production.
5. Cause of dissatisfaction:
There may be difference in earning of various workers. Some may
earn less and others may earn more. Those who get low wages feel so
jealous of others who earn more and this becomes a cause of

dissatisfaction among slow workers. Thus, this system can see
dissatisfaction among workers.
6. Opposition from unions:
Piece-rate system of paying wages is opposed by trade unions. There
is an unhealthy competition among workers for increasing their
wages. It encourages rivalry among workers and it may become a
cause of disunity.
The existence of unions is endangered when some section among
them feel jealous of other. Union will never support a system where
workers earn different amounts of wages and this becomes a cause of
disharmony among them. So trade unions oppose this system.
7. Difficulty in fixing piece-rates:
The fixation of piece rates is not an easy job. If a low rate is fixed
then workers may not feel encouraged to increase their production.
When a high piece-rate is fixed then it will increase the cost of
production of goods. The fixation of piece rate may become a cause
of an industrial dispute. It may be very difficult to fix a rate
acceptable to workers as well as management.
Suitability:
Piece rate system is suitable under following situations:
(1) Where production quantity is more important than the quality of
the product.
(2) When the work is of repetitive nature.
(3) When the mass manufacturing system of production is followed
and the work is standardized suitable for continuous manufacturing.
(4) When it is possible to measure the production output of worker
separately.
(5) When strict supervision is not required and difficult.
(6) When the production is dependent on human efforts.
Types of Piece Rate System:
Piece rate system may be of following three types:
(i) Straight piece rate
(ii) Increasing piece rate
(iii) Decreasing piece rate

(i) Straight piece rate:
In this system, the piece rate forms the basis of payment i.e. payment
for whole production is made on the basis of piece rate fixed. If the
piece rate of Rs. 1.5 per .unit is fixed, then the wages will be
calculated by multiplying the output by the rate fixed.
A worker producing 200 units will get Rs. 3000 (i.e. 200 x 15). If the
production output is raised to 210 the wages will be Rs. 3150 (210 x
15). Thus a worker will have to increase the output in order to get
higher wages. The rate of payment remains same irrespective of
production level or level of output.
(ii) Increasing piece rate:
In this system different rates are fixed for different levels of
production. A certain production level is decided and if the production
goes beyond that level, higher rates are given. For example, a piece
rate of Rs. 21- per unit may be fixed for production up to 100 units,
Rs 2.10 per unit for output between 101 to 150 units and Rs. 2.25 per
unit for a production beyond 150 units and so no. There is an
incentive to get higher rate for production beyond a certain level.
(iii) Decreasing piece rate:
In certain cases, where quality is of great consideration, this system is
followed to discourage negligence of workers. In this method, the rate
per unit decreases with increase in output. For example Re. 1/- per
unit may be allowed up to a certain production level say 100 units.
Re. 0.95 per unit for production between 100 to 150 units and Re.
0.90 per unit for an output beyond 150 units and so on
3.INCENTIVE WAGE METHOD
The wage plan should be highly incentive means it should encourage
workers to take more initiative and interest in the work, produce more
and also earn more. The wage plan which serves all these purposes is
called incentive wage plan. Such an incentive plan is beneficial to
both - employers and employees as well as it is useful for the rapid
industrial growth.
Incentives include monetary as weft as non-monetary benefits offered.
There is motivation to work hard and to earn more. In every incentive
plan, wages are linked with the given output. Incentives are not fixed

like wages and salaries. They vary from individual to individual and
from period to period.
ILO defines incentives as "payment by results". Incentives can also be
described as "incentive systems of payment".
According to Dale Yoder, “Incentive wages relate earnings to
productivity and may use premiums, bonuses, or a variety of rates to
compensate for superior performance” Piece rate system is the oldest
incentive wage plan which is also useful for attracting and retaining
qualified personnel in the organisation and for motivating personnel
to higher levels of performance. In many incentive plans, a
combination of time rate and piece rate sysh3ms is used. Such
combination creates an ideal incentive plan.
TYPES OF INCENTIVE PLANS
1. Individual Incentive (PBR) Schemes:
Under this plan, employees are paid on the basis of results”. The chief
incentive plans included in this category are discussed in seriatim.
A)Taylor’s Differential Piece Rate Plan:
This plan was developed by F. W. Taylor, the father of scientific
management. Under this plan, Taylor prescribed two piece work rates.
One, a higher wage rate for those who reach the standard work.
Second, a lower wage rate whose performance is below the standard.
The standard work is determined on the basis of time and motion
studies. This wage plan encourages and rewards the employees who
are efficient by giving them wages at a higher rate. At the same time,
the plan penalizes those who are slow performers by paying them at a
low wage rate.
B)Halsey Premium Plan:
This plan, originated by F. A. Halsey, an American engineer, is a
combination of the time and the piece wage in a modified form.
Under this plan, a guaranteed wage based on past experience is
determined. If a worker saves time, he gets 50% of wages for time
saved (called premium) in addition to normal wages. It is optional for
the worker to work on the premium or not. Thus, this plan also
provides incentive to efficient workers.

C)Rowan Premium Plan:
This plan was developed by D. Rowan in 1901. This plan, to a large
extent IS similar to that of Halsey Premium Plan. The only difference
is in regard to the determination of the premium. Unlike a fixed
percentage in case of Halsey plan, it considers premium on the basis
of the proportion which the time saved bears to the standard time.
D)Emersson Efficiency Plan:
Under this scheme, both standard work and day wage are fixed.
Bonus is paid on the basis of worker’s efficiency. A worker becomes
entitled to get bonus only when his/her efficiency reaches to 67%.
The rate of bonus goes on increasing till he achieves 100% efficiency.
Above 100% efficiency, bonus will be 20% of the basic rate plus 1%
for each 1% increase in efficiency. In this way, at 120% efficiency, a
worker receives a bonus of 40% and at 140% efficiency worker gets
60% of the day wage as bonus.
E)Gantt Task and Bonus Plan:
This plan is devised by H. L. Gantt. This plan combines time, piece
wage and bonus. Standard time, piece wage and high rate per piece
are determined. A worker who cannot complete standard work within
standard time is paid only the minimum guaranteed wage. A worker
performing up to the standard level of work gets time wage plus a
bonus @ 20% of normal time wage. If the worker exceeds the
standard, he is paid a higher piece rate but there is no bonus.
The above mentioned various incentive schemes indicate that the
incentive may vary along with variation in earning with changes in
performance or output.
2. Group Incentive Schemes:
The incentive schemes can be applied on a group basis also. Group
incentive schemes are appropriate where jobs are interdependent. It is
difficult to meaningfully measure individual performance and group
pressures affect the performance of the members of the group. The
chief group incentive schemes are discussed here.
A)Profit-sharing:
The concept of profit-sharing emerged towards the end of the
nineteenth century. Profit-sharing, as the name itself suggests, is
sharing of profit of organisation among employees. The International

Co-operative Congress” held in Paris in 1889 considered the issue of
profit-sharing and defined it as “an agreement (formal or informal)
freely entered into by which an employee receives a share fixed in
advance of the profits”.
The basic rationale behind profit-sharing is that the organisational
profit is an outcome of the co-operative efforts of various parties,
therefore, employees should also share in profits as shareholders share
by getting dividend on their investment, i.e. share capital. The very
purpose of introducing profit-sharing is to strengthen the loyalty of
employees to the organisation. Thus, profit-sharing is regarded as a
stepping stone to industrial democracy.
Both the share (percentage) of profit to be shared by employees and
mechanism for its distribution are determined in advance and also
made known to the employees. In order to be eligible to participate in
profit-sharing. An employee needs to serve for a certain number of
years and, thus, earn some seniority. As regards the forms of profit-
sharing, Metzger has classified these into three categories, namely,
B)Co-partnership:
In a way, co-partnership is an improvement over profit-sharing. In
this scheme, employees also participate in the equity capital of a
company. They can have shares either on the basis of cash payment or
in lieu of other incentives payable in cash like bonus. Thus, under co-
partnership scheme, employees become shareholders also by having
company shares. Now, employees participate in both —profits and
management of the company.
The finer points of this scheme are that it recognizes the dignity of
labour and also of a partner in the business. This would, in turn,
develop a sense of belongingness among the employees and
encourage them to contribute their best for the development of the
organisation.
C)Scanlon Plan:
The Scanlon plan was developed by Joseph N. Scanlon, a Lecturer at
the Massachusetts Institute of Technology in USA in 1937. The plan
is essentially a suggestion scheme designed to involve the workers in
making suggestions for reducing the cost of operation and improving
working methods and sharing in the gains of increased productivity.

The plan is characterised by two basic features. First, both employees
and managers can participate in the plan by submitting their
suggestions for cost-cutting methods. Second, increase in efficiency
on account of cost-cutting is shared by the employees of the unit.
The Scanlon plan, wherever adopted, has been successful to
encourage a sense of partnership among employees, improved
employee-employer management relations, and increased motivation
to work.
The criticism labelled against group incentive is that the incentive
benefits being similar to all members of the group, the best
performers may loose incentive. However, this can be overcome if
group incentive scheme generates peer-level pressure for superior
performance and also reduces the need for supervision. Stability in
group may be a necessary condition to make the group incentive
scheme successful.
As regards the ultimate impact of incentives on organisational
performance, the research studies” conducted in India report that
incentive schemes have a positive impact on productivity, labour cost,
and industrial relations. It is concluded that “money” has a “salutary”
impact on production.
Basic Requirements of Sound Wage-Incentive System
(i) Sound policies:
There must be a set of sound wage-administration policies, preferably
in writing, which are fair to both management and the employees and
which are such that organisation can maintain its competitive
position. These policies and incentive plans must be clearly
understood by all members of the management team whose decision
can in any way affect the wages paid to the employees.
(ii) Workers’ participation:
Wage incentive plan is installed primarily to benefit the persons who
will in any way be affected by its installation. So the management
must discuss the wage incentive system with the employees and their
representatives.
(iii) Scientific system for fixing standard workload:
Under the incentive plan, extra payment is given for the extra work,
i.e., work which is over and above certain standard quantity. Such

standard work-load must be clear, specific and fixed with scientific
time studies so that majority of the employees are able to give extra
production for extra payment. Incentive wage plan will be
meaningless if majority of workers remain away from its benefits.
(iv) Simplicity:
A good incentive plan is one which is easy to understand and simple
to operate. An average worker must be able to know the incentives
offered and what he is expected to do. The monetary benefits must be
made clear to all workers. This will create initiative and interest
among them.
(v) Guarantee of minimum wage payment:
An incentive wage plan must ensure certain minimum wage payment
to every worker per month. This should be irrespective of the
production he gives. Such provision of minimum guarantee payment
creates a sense of security and confidence among the workers.
(vi) Definiteness:
An incentive plan must be definite. This means frequent changes
should not be made as such changes create confusion and doubts in
the minds of workers. Such plan must give clear benefits to workers.
(vii) Wide coverage:
An incentive plan should not be for employees of certain sections
only. It should have wide coverage and almost all employees should
be covered by such plan. Such wide coverage makes the plan popular
at all levels and among all categories of workers. In addition, an
incentive plan should be equitable. This means it should provide equal
opportunity to all employees to show efficiency and earn more.
(viii) Follow up:
Management must constantly and carefully follow up and check up to
see the her employees are adhering to the specifications. Similarly,
management must observe whether the standards are being met or not.
The reasons for any deficiency should be instigated and corrective
steps taken to facilitate the smooth functioning of wage incentive
system.
(ix) No upper limit:
The wage incentive system should place no upper limit on incentive
earnings. This is so because the more the worker produces, the more

the organisation will be benefited in general. Therefore, if a selling is
put to the incentive earnings, it may also curtail the opportunity to
achieve lower production costs per unit.
FRINGE BENEFITS
A collection of various benefits provided by an employer, which are
exempt from taxation as long as certain conditions are met. Any
employee who receives taxable fringe benefits will have to include
the fair market value of the benefit in their taxable income for the
year, which will be subject to tax withholdings, and social security
benefits payments
TYPES OF FRINGE BENEFITS
It is important to understand the different types of fringe benefit
categories and the applicable grossed up value they represent in the
FBT calculation.
Common fringe benefits Non Profit Employers provide to employees
are:
 Car fringe benefits
 Tax-exempt body entertainment and meal entertainment fringe
benefits
 Expense payment fringe benefits
Other fringe benefits that can be provided include:
 Car parking fringe benefits
 Property and residual fringe benefits
 Living away from home or relocation related fringe benefits
 Housing and board fringe benefits
 Loan and debt waiver fringe benefits
OBJECTIVES OF FRINGE BENEFITS
The view point of employers is that fringe benefits form an important
part of employee incentives to obtain their loyalty and retaining them.
The important objectives of fringe benefits are:
1.To create and improve sound industrial relations
2.To boost up employee morale.
3.To motivate the employees by identifying and satisfying their
unsatisfied needs.
4.To provide qualitative work environment and work life.
5.To provide security to the employees against social risks like old
age benefits and maternity benefits.
6.To protect the health of the employees and to provide safety to the
employees against accidents.
7.To promote employee’s welfare by providing welfare measures like
recreation facilities.
8.To create a sense of belongingness among employees and to retain
them. Hence, fringe benefits are called golden hand-cuffs.
9.To meet requirements of various legislations relating to fringe
benefits.
Need for Extending Benefits to Employees
(i)Rising prices and cost of living has brought about incessant demand
for provision of extra benefit to the employees.
(ii)Employers too have found that fringe benefits present attractive
areas of negotiation when large wage and salary increases are not
feasible.
(iii)As organizations have developed ore elaborate fringe benefits
programs for their employees, greater pressure has been placed upon
competing organizations to match these benefits in order to attract and
keep employees.
(iv)Recognition that fringe benefits are non-taxable rewards has been
major stimulus to their expansion.
(v)Rapid industrialization, increasingly heavy urbanization and the
growth of a capitalistic economy have made it difficult for most
employees to protect themselves against the adverse impact of these
developments. Since it was workers who are responsible for
production, it was held that employers should accept responsibility for
meeting some of the needs of their employees. As a result, some
benefits-and-services programs were adopted by employers
(vi)The growing volume of labor legislation, particularly social
security legislation, made it imperative for employers to share equally
with their employees the cost of old age, survivor and disability
benefits.
(vii)The growth and strength of trade unions has substantially
influenced the growth of company benefits and services.
(viii)Labor scarcity and competition for qualified personnel has led to
the initiation, evolution and implementation of a number of

compensation plans.
(ix)The management has increasingly realized its responsibility
towards its employees and has come to the conclusion that the
benefits of increase in productivity resulting from increasing
industrialization should go, at least partly, to the employees who are
responsible for it, so that they may be protected against the insecurity
arising from unemployment, sickness, injury and old age. Company
benefits-and-services programs are among some of the mechanisms
which managers use to supply this security.
QUALITY OF WORK LIFE
The present era is an era of knowledge workers and the society in
which we are living has come, to be known as knowledge society.
The intellectual pursuits have taken precedence over the physical
efforts.
Some knowledge workers work for more than 60 hours a week. As a
result of this, their personal hobbies and interests clash with their
work. Life is a bundle that contains all the strands together and hence
the need to balance work life with other related issues.’
One must have both love and work in one’s life to make it healthy.
Gone are the days when the priority of employees used to be for
physical and material needs. With the increasing shift of the economy
towards knowledge economy, the meaning and
has undergone a drastic change.
Meaning:
Quality of work life (QWL) refers to the favourableness or
unfavourableness of a job environment for the people working in an
organisation. The period of scientific management which focused
solely on specialisation and efficiency, has undergone a revolutionary
change.
The traditional management (like scientific management) gave
inadequate attention to human values. In the present scenario, needs
and aspirations of the employees are changing. Employers are now
redesigning jobs for better QWL.
DEFINITION
“QWL is a process of work organisations which enable its members at
all levels to actively; participate in shaping the organizations

environment, methods and outcomes. This value based process is
aimed towards meeting the twin goals of enhanced effectiveness of
organisations and improved quality of life at work for employees. ”—
The American Society of Training and Development
“QWL is a way of thinking about people, work and organisations, its
distinctive elements are (i) a concern about the impact of work on
people as well as on organisational effectiveness, and (ii) the idea of
participation in organisational problem-solving and decision making.
” —Nadler and Lawler
The overriding purpose of QWL is to change the climate at work so
that the human-technological-organisational interface leads to a better
quality of work life.”-Luthans
TECHNIQUES FOR IMPROVING QUALTY OF WORK
LIFE:-
1. Job Enrichment:
Under traditional management, the principle of division of work and
specialisation was applied so that an individual could do a particular
work more efficiently. However, this made the job of workers
monotonous. They started feeling bored by doing the same work
again and again. Management also started realising it as a process of
dehumanisation.
Kerzberg in his two factor theory of motivation tried to use job as a
medium of developing people and changing some organisational
practices. Job enrichment can lead to extension of job contents. It also
develops competence of employees who voluntarily come forward to
share higher responsibilities.
2. Job Rotation:
A vertical job rotation means promotion whereas a horizontal job
rotation means transfer to some other job. Job rotation makes an
employee to learn the new job at the new seat thereby creating interest
in the new job. The problems associated with specialisation such as
boredom and monotony are automatically removed as the worker
becomes generalist from specialist.

3. Quality Circles (or Self-managed Work Teams):
The concept of Quality Circles was made popular in Japan in 1960 by
K. Ishikawa. Japan has gained a lot by applying the Statistical Quality
Control (SQC) techniques for production.
Quality circles can be defined as a small group of some people (may
be 3 to 12) who meet for an hour every week to identify, analyse and
solve the problems related to their work. The solutions are sent to the
management for implementation.Quality Circles develop a culture of
participation among the workers. It also reflects the democratic set up
where the management keeps full faith in the employees and also
there is a complete understanding between the management and
workers
4.Recognize good work. How can something so simple improve
quality of work? As GenY starts to become one of the largest
demographics in the workforce they rely on constant recognition. You
must ensure that as an employer you always have something positive
to say about your employees and their work. Don’t rely on the old
principle if you don’t say anything that means everything is fine,
because GenY will take that as things being worse. Rewards, and
other ways of keeping employees happy will make them feel that their
effort is being recognized and that the company needs them.
5.Set goals, reward if met. Have production goals that need to be
met by the end of the day? Set a goal and do something fun if the goal
is met. Giving your employees a challenge throughout the day will
give them something to work towards and generally they will go
above and beyond to meet the goal. For example, focus on production
goals or deadlines that have to be met. If they meet them ahead of
schedule, go out for happy hour on the company, extend their lunches,
or if viable, let them take half a day. These simple rewards will
revitalize your employees and give them more drive to produce the
same results outside a rewards system.
Process of QWL
a. Adequate and fair compensation
b. Safe and healthy working conditions
c. Immediate opportunity to use and develop human capacities
d. Future opportunity for continued growth and security

e. Social integration in the work organization
f. Work and total life space
g. Social relevance of working life
From studies carried out, both in India and abroad, it is evident that
the essence of QWL is the opportunity for employees, at all levels, to
have substantial influence over their work environment. This is a
result of their participating in the decision-making process related to
their work, thereby enhancing their self-esteem and the overall
satisfaction from their work.
Hence, QWL calls for an open style of management that is, sharing of
information and genuinely encouraging the efforts relating to the
improvement of the organization. This makes it amply clear that
QWL, in fact, is an important managerial activity to develop the
employees of an organization.
The success of TQM programmes largely depend on appropriate
OB/HR interventions such as emphasis on continuous training and
development activity, encouraging participation in management
through small group forums, increasing employees’ motivation,
looking after the career development of employees, employee
empowerment, and infusing attitudinal changes at the top (like
accepting a flatter organizational structure, following a democratic
approach, becoming receptive to changes on a continuous basis,
supporting group performance, etc.).
EMPLOYEES WELFARE
Welfare includes anything that is done for the comfort and
improvement of employees and is provided over and above the wages.
Welfare helps in keeping the morale and motivation of the employees
high so as to retain the employees for longer duration. The welfare
measures need not be in monetary terms only but in any kind/forms.
Employee welfare includes monitoring of working conditions,
creation of industrial harmony through infrastructure for health,
industrial relations and insurance against disease, accident and
unemployment for the workers and their families.
Labor welfare entails all those activities of employer which are
directed towards providing the employees with certain facilities and
services in addition to wages or salaries.

Labor welfare has the following objectives:
 To provide better life and health to the workers
 To make the workers happy and satisfied
 To relieve workers from industrial fatigue and to improve
intellectual, cultural and material conditions of living of the workers.
The basic features of labor welfare measures are as follows:
 Labor welfare includes various facilities, services and amenities
provided to workers for improving their health, efficiency, economic
betterment and social status.
 Welfare measures are in addition to regular wages and other
economic benefits available to workers due to legal provisions and
collective bargainin.
 Labor welfare schemes are flexible and ever-changing. New
welfare measures are added to the existing ones from time to time.
 Welfare measures may be introduced by the employers,
government, employees or by any social or charitable agenc
 The purpose of labor welfare is to bring about the development
of the whole personality of the workers to make a better workforce.
India. The Factories act was enacted in the year 1948. The main
objective of this law is to maintain healthy, safety and welfare of
every employee at workplace in factory . According to this law any
factory with above 500 workers should have separate welfare officer,
factory with 1000 above workers should have separate safety officer,
for 500 workers should have ambulance facility and for above 250
workers canteen facility with concession should be provided.
Some of the provisions relating to the Labour Welfare as mentioned
in the Factories Act, 1948 are: (1) Washing Facilities (2) Facilities for
storing and drying clothing (3) Facilities for sitting (4) First aid
appliances (5) Canteens (6) Shelters, rest rooms and lunch rooms (7)
Creches and (8) Welfare officers
The Factories Act, 1948 contains the following provisions relating
to Labour Welfare:
(1) Washing Facilities:
In every factory (a) adequate and suitable facilities shall be provided
and maintained for the use of workers; (b) separate and adequately
screened facilities shall be provided for the use of male and female
workers; (c) such facilities shall be easily accessible and shall be kept
clean.
(2) Facilities for storing and drying clothing:
In every factory provision for suitable place should exist for keeping
clothing not worn during working hours and for the drying of wet
clothing.
(3) Facilities for sitting:
In every factory, suitable arrangements for sitting shall be provided
and maintained for all workers who are obliged to work in a standing
position so that the workers may take advantage of any opportunity
for rest which may occur in the course of work. If in any factory
workers can efficiently do their work in a sitting position, the Chief
inspector may require the occupier of the factory to provide such
seating arrangements as may be practicable.
(4) First aid appliances:
Under the Act, the provisions for first-aid appliances are obligatory.
At least one first-aid box or cupboard with the prescribed contents
should be maintained for every 150 workers. It should be readily
accessible during all working hours.
Each first-aid box or cupboard shall be kept in the charge of a
separate responsible person who holds a certificate in the first-aid
treatment recognised by the State Government and who shall always
be readily available during the working hours of the factory.
In every factory wherein more than 500 workers are ordinarily
employed there shall be provided and maintained an ambulance room
of the prescribed size containing the prescribed equipment. The
ambulance room shall be in the charge of properly qualified medical
and nursing staff. These facilities shall always be made readily
available during the working hours of the factory.
(5) Canteens:
In every factory employing more than 250 workers, the State
government may make rules requiring that a canteen or canteens shall
be provided for the use of workers. Such rules may provide for (a) the
date by which the canteen shall be provided, (b) the standards in
respect of constitution, accommodation, furniture and other
equipment of the canteen; (c) the foodstuffs to be served therein and

charges which may be paid thereof; (d) the constitution of a managing
committee for the canteens and representation of the workers in the
management of the canteen; (e) the items of expenditure in the
running of the canteen which are not to be taken into account in fixing
the cost of foodstuffs and which shall be borne by the employer; (f)
the delegation to the Chief inspector, of the power to make rules
under clause (c).
(6) Shelters, rest rooms and lunch rooms:
In every factory wherein more than 150 workers are ordinarily
employed, there shall be a provision for shelters, rest room and a
suitable lunch room where workers can eat meals brought by them
with provision for drinking water.
Where a lunch room exists, no worker shall eat any food in the work
room. Such shelters or rest rooms or lunch rooms shall be sufficiently
lighted and ventilated and shall be maintained in a cool and clean
condition.
(7) Creches:
In every factory wherein more than 30 women workers are ordinarily
employed there shall be provided and maintained a suitable room or
rooms for the use of children under the age of six years of such
women.
Such rooms shall provide adequate accommodation, shall be
adequately lighted and ventilated, shall be maintained in clean and
proper sanitary conditions and shall be under the charge of women
trained in the care of children and infants.
The State government may make rules for the provision of
additional facilities for the care of children belonging to women
workers including suitable provision of facilities:—
(a) For washing and changing their clothing
(b) of free milk or refreshment or both for the children, and
(c) for the mothers of children to feed them at the necessary intervals.
(8) Welfare officers:
In every factory wherein 500 or more workers are ordinarily
employed, the occupier shall employ in the factory such number of
welfare officers as may be prescribed under Sec. 49(1). The State

government may prescribe the duties, qualifications and conditions of
service of such officers.
Employee Welfare Schemes
Organizations provide welfare facilities to their employees to keep
their motivation levels high. The employee welfare schemes can be
classified into two categories viz. statutory and non-statutory welfare
schemes. The statutory schemes are those schemes that are
compulsory to provide by an organization as compliance to the laws
governing employee health and safety. These include provisions
provided in industrial acts like Factories Act 1948, Dock Workers Act
(safety, health and welfare) 1986, Mines Act 1962. The non-statutory
schemes differ from organization to organization and from industry to
industry.
STATUTORY WELFARE SCHEMES
The statutory welfare schemes include the following provisions:
1. Drinking Water: At all the working places safe hygienic
drinking water should be provided.
2. Facilities for sitting: In every organization, especially factories,
suitable seating arrangements are to be provided.
3. First aid appliances: First aid appliances are to be provided and
should be readily assessable so that in case of any minor accident
initial medication can be provided to the needed employee.
4. Latrines and Urinals: A sufficient number of latrines and
urinals are to be provided in the office and factory premises and are
also to be maintained in a neat and clean condition.
5. Canteen facilities: Cafeteria or canteens are to be provided by
the employer so as to provide hygienic and nutritious food to the
employees.
6. Spittoons: In every work place, such as ware houses, store
places, in the dock area and office premises spittoons are to be
provided in convenient places and same are to be maintained in a
hygienic condition.
7. Lighting: Proper and sufficient lights are to be provided for
employees so that they can work safely during the night shifts.

8. Washing places: Adequate washing places such as bathrooms,
wash basins with tap and tap on the stand pipe are provided in the port
area in the vicinity of the work places.
9. Changing rooms: Adequate changing rooms are to be provided
for workers to change their cloth in the factory area and office
premises. Adequate lockers are also provided to the workers to keep
their clothes and belongings.
10. Rest rooms: Adequate numbers of restrooms are provided to
the workers with provisions of water supply, wash basins, toilets,
bathrooms, etc.
NON STATUTORY SCHEMES:-
1. Personal Health Care (Regular medical check-ups): Some of
the companies provide the facility for ext
2. ensiv
e health check-up
3. Flexi-time: The main objective of the flextime policy is to
provide opportunity to employees to work with flexible working
schedules. Flexible work schedules are initiated by employees and
approved by management to meet business commitments while
supporting employee personal life needs
4. Employee Assistance Programs: Various assistant programs
are arranged like external counseling service so that employees or
members of their immediate family can get counseling on various
matters.
5. Harassment Policy: To protect an employee from harassments
of any kind, guidelines are provided for
6. proper action and also for protecting the aggrieved employee.
7. Maternity & Adoption Leave – Employees can avail maternity
or adoption leaves. Paternity leave policies have also been introduced
by various companies.
8. Medi-claim Insurance Scheme: This insurance scheme
provides adequate insurance coverage of employees for expenses
related to hospitalization due to illness, disease or injury or
pregnancy.

9. Employee Referral Scheme: In several companies employee
referral scheme is implemented to encourage employees to refer
friends and relatives for employment in the organization.
HEALTH
Section 11. Cleanliness.-
(1) Every factory shall be kept clean and free from effluvial arising
from any drain, privy or other nuisance, and in particular-
 (a) accumulation of dirt and refuse shall be removed daily by
sweeping or by any other effective method from the floors and
benches of workrooms and from staircases and passages and disposed
of in a suitable manner;
 (b) the floor of every workroom shall be cleaned at least once in
every week by washing, using disinfectant where necessary, or by
some other effective method;
 (c) where a floor is liable to become wet in the course of any
manufacturing process to such extent as is capable of being drained,
effective means of drainage shall be provided as maintained;
o (d) all inside walls and partitions, all ceilings or tops of
rooms and all walls, sides and tops of passages and staircases shall- (i)
where they are 'tpainted otherwise than with washable water paint or
varnished, be repainted or revarnished at least once in every period of
five years;
o (i-a) where they are painted with washable water paint, be
repainted with at least one coat of such paint at least once in every
period ofthree years and washed at least once in every period of six
months;
o (ii) where they are painted or varnished or where they have
smooth impervious surfaces, be cleaned at least one in every period of
fourteen months by such methods as may be prescribed;
o (iii) in any other case, be kept whitewashed, or colour
washed, and the whitewashing or colourwashing shall be carried out
at least once in every period of fourteen months;
 (dd) all doors and window-frames and other wooden or metallic
framework and shutters shall be kept painted or varnished and the
painting or varnishing shall be carried out at least once in every
period of five years;

 (e) the dates on which the processes required by clause (d) are
carried out shall be entered in the prescribed register.
(2) If, in view of the nature of the operations carried on in a factory or
class or description of factories or any part of a factory or class or
description of factories, it is not possible for the occupier to comply
with all or any of the provisions of sub-section (1), the State
Government may by order exempt such factory or class or descriptien
of factories or part from any of the provisions of that sub-section and
specify alternative methods for keeping the factory in a clean state.
Section 12. Disposal of wastes and effluents.-
(1) Effective arrangements shall be made in every factory for the
treatment of wastes and effluents due to the manufacturing process
carried on therein, so as to render them innocuous, and for their
disposal.
(2) The State Government may make rules prescribing the
arrangements to be made under sub-section (1) or requiring that the
arrangements made in accordance with sub-section (1) shall be
approved by such authority as may be prescribed.
Section 13. Ventilation and temperature.-
(1) Effect and suitable provisions shall be made in every factory for
securing and maintaining in every workroom-
 (a) adequate ventilation by the circulation of fresh air, and
 (b) such a temperature as will secure to workers therein
reasonable conditions of comfort and prevent injury to health; and in
particular,
o (i) walls and roofs shall be of such material and so
designed that such temperature shall not be exceeded but kept as low
as practicable;
o (ii) where the nature of the work carried on in the factories
involves, or is likely to involve, the production of excessively high
temperature, such adequate measures as are practicable shall be taken
to protect the workers therefrom, by separating the process, which
produces such temperature from the workroom, by insulating the hot
parts or by other effective means.
(2) The State Government may prescribe a standard of adequate
ventilation and reasonable temperature for any factory or class or

description of factories or parts thereof and direct that proper
measuring instruments, at such places and in such position as may be
specified, shall be provided and such records, as may be prescribed,
shall be maintained.
(3) If it appears to the Chief Inspector that excessively high
temperature in any factory can be reduced by the adoption of suitable
measures, he may, without prejudice to the rules made under sub-
section (2), serve on the occupier, an order in writing specifying the
measures which, in his opinion should be adopted, and requiring them
to be carried out before a specified date.
Section 14. Dust and fume.-
(1) In every factory in which, by reason of the manufacturing process
carried on, there is given off any dust or fume or other impurity of
such a nature and to such an extent as is likely to be injurious or
offensive to the workers employed therein, or any dust in substantial
quantities, effective measures shall be taken to prevent its inhalation
and accumulation in any workroom, and if any exhaust appliance is
necessary for this purpose, it shall be applied as near as possible to the
point of origin of the dust, fume or other impurity, and such point
shall be enclosed so far as possible.
(2) In any factory no stationary internal combustion engine shall be
operated unless the exhaust is conducted into the open air, and no
other internal combustion engine shall be operated in any room ualess
effective measures have been taken to prevent such accumulation
offumes therefrom as are likely to be injurious to workers employed
in the room.
Section 15. Artificial humidification.-
(1) In respect of all factories in which the humidity of the air is
artificially increased, the State Government may make rules,-
 (a) prescribing standards of humidification;
 (b) regulatingthe methods used for artificially increasing the
humidity of the air;
 (c) directing prescribed tests for determining the humidityof the
air to be correctly carried out and recorded;
 (d) prescribing methods to be adopted for securing adequate
ventilation and cooling of the air in the workrooms.

(2) In any factory in which the humidity of the air is artificially
increased, the water used for the purpose shall be taken from a public
supply, or other source of drinking water, or shall he effectively
purified before it is so used.
(3) If it appears to an Inspector that the water used in a factory for
increasing humidity which is required to be effectively purified under
sub-section (2) is not effectively purified he may serve on the
manager of the factory an order in writing, specifying the measures
which in his opinion should be adopted, and requiring them to be
carried out before specified date.
Section 16. Overcrowding.-
No room in any factory shall be overcrowded to an extent injurious to
the health of the workers employed therein.
(2) Without prejudice to the generality of sub-section (1), there shall
be in every workroom of a factory in existence on the date of
commencement of this Act at least 9.9 cubic metres and of a factory
built after the commencement ofthis Act at least 14.2 cubic metres of
space for every worker employed therein, and for the purposes of this
sub-section no account shall be taken of anyspace which is more than
4.2 metres above the level of the fioor of the room.
(3) If the Chief Inspector by order in writing so requires, there shall
be posted in each workroom of a factory a notice specifying the
maximum number of workers who may, in compliance with the
Provisions of this section, be employed in the room.
(4) The Chief Inspector may, by order in writing exempt, subject to
such conditions, if any, as he may thing fit to impose, any workroom
from the provisions of this section, if he is satisfied that compliance
therewith in respect of the room is unnecessary in the interest of the
health of the workers employed therein.
Section 17. Lighting.-
(1) In every part of a factory where workers are working or passing,
there shall be provided and maintained sufficient and suitable
lighting, natural or artificial, or both.
(2) In every factory all glazed windows and skylights used for the
lighting of the workroom shall be kept clean on both the inner and
outer surfaces and, so far as compliance with the provisions of any

rules made under sub-section (3) of section 13 will allow, free from
obstruction.
(3) In every factory effective provision shall, so far as is practicable,
be made for the prevention of-
 (a) glare, either directly from a source of light or by reflection
from a smooth or polished surface;
 (b) the formation of shadows to such an extent as to cause eye-
strain or the risk of accident to any worker.
(4) The State Government may prescribe standards of sufficient and
suitable lighting for factories or for any class or description
offactories or for any manufacturing process.
Section 18. Drinking water.-
(1) In every factory effective arrangements shall be made to provide
and maintain at suitable points conveniently situated for all workers
employed therein a sufficient supply of wholesome drinking water.
(2) All such points shall be legibly marked "drinking water" in a
language understood by a majority of the workers employed in the
factory and no such points shall be situated within 1[six metres of any
washing place, urinal, latrine, spittoon, open drain carrying sullage or
effluent or any other source of contamination unless a shorter distance
is approved in writing by the Chief Inspector.
(3) In every factory wherein more than two hundred and fifty workers
are ordinarily employed, provisions shall be made for cooling
drinking water during hot weather by effective means and for
distribution thereof.
(4) In respect of all factories or any class or description of factories
the State Government may make rules for securing compliance with
the provisions of sub-sections (1), (2) and (3) and for the examination
by prescribed authorities of the supply and distribution of drinking
water in factories.
Section 19. Latrines and urinals.-
(1) In every factory-
 (a) sufficient latrine and urinal accommodation of prescribed
types shall be provided conveniently situated and accessible to
workers at all times while they are at the factory;

 (b) separate enclosed accommodation shall be provided for male
and female workers;
 (c) such accommodation shall be adequately lighted and
ventilated and no latrine or urinal shall, unless specially exempted in
writing by the Chief Inspector, communicate with any workroom
except through an intervening open space or ventilated passage;
 (d) all such accommodation shall be maintained in a clean and
sanitary condition at all times;
 (e) sweepers shall be employed whose primary duty it would be
to keep clean all latrines, urinals and washing places.
(2) In every factory wherein more than twohundred and fifty workers
are ordinarily employed-
 (a) all latrine and urinal accommodation shall be of prescribed
sanitary types;
 (b) the floors and internal walls, up to a height of ninety
centimetres of the latrines and urinals and the sanitary blocks shall be
laid in glazed tiles or otherwise finished to provide a smooth polished
impervious surface;
 (c) without prejudice to the provisions of clauses (d) and (e) of
sub-section (1), the fioors, portions of the walls and blocks so laid or
finished and the sanitary pans of latrines and urinals shall be
thoroughly washed and cleaned at least once in every seven days with
suitable detergents or disinfectants or with both.
(3) The State Government may prescribe the number of latrines and
urinals to be provided in any factory in proportion to the number of
male and female workers ordinarily employed therein, and provide for
such further matters in respect of sanitation in factories, including the
obligation of workers in this regard, as it considers necessary in the
interest of the health of the workers employed therein.
Section 20. Spittoons.-
(1) In every factory there shall be provided a sufficient number of
spittoons in convenient places and they shall be maintained in a clean
and hygienic condition.
(2) The State Government may make rules prescribing the type and
numbers of spittoons to be provided and their location in any factory

and provide for such further matters relating to their maintenance in a
clean and hygienic condition.
(3) No person shall spit within the premises of a factory except in the
spittoons provided for the purpose and a notice containing this
provision and the penalty for its violation shall be prominently
displayed at suitable places in the premises.
(4) Whoever spits in contravention of sub-section (3) shall be
punishable with fine not exceeding five rupees.
SAFETY
Section 21. Fencing of machinery.-
(1) In every factory the following, namely-
 (i) every moving part of a prime-mover and every fiywheel
connected to a prime-mover, whether the prime-mover or flywheel is
in the engine-house or not;
 (ii) the headrace and tailrace of every water-wheel and water-
turbine;
 (iii) any part of a stock bar which projects beyond the head stock
of a lathe; and
 (iv) unless they are in such position or of such construction as to
be safe to every person employed in the factory as they would be if
they were securely fenced, the following, namely:-
o (a) every part of an electric generator, a motor or rotary
convertor;
o (b) every part of transmission machinery; and
o (c) every dangerous part of any other machinery; shall be
securely fenced by safeguards of a substantial construction which
shall be constantly maintained and kept in position while the parts of
machinery they are fencing, are in motion or in use:
Provided that for the purpose of determining whether any part of
machinery in such position or is of such construction as to be safe as
aforesaid, account shall not be taken of any occasion when-
 (i) it is necessary to make an examination of any part of the
machinery aforesaid while it is in motion or, as a result of such
examination to carry out lubrication or other adjusting operation while
the machinery is in motion, being an examination of operation which

it is necessary to be carried out while that part of the machinery is in
motion. or
 (ii) in the case of any part of a transmission machinery used in
such process as may be prescribed (being a process of a continuous
nature, the carrying on of which shall be or is likely to be
substantially interfered with by the stoppage of that part of the
machinery), it is necessary to make an examination of such part of the
machinery while it is in motion or, as a result of such examination, to
carry out any mounting or shipping of belts or lubrication, or other
adjusting operation while tlle machinery is in motion, and such
examination or operation is made or carried out in accordance with
the provisions of sub-section (1) of section 22.
(2) The State Government may by rules prescribe such further
precautions as it may consider necessary in respect of any particular
machinery or part thereof or exempt, subject to such condition as may
be prescribed, for securing the sefetyofthe workers, any particular
machinery or part thereof from the Provisions of this section.
Section 22. Work on or near machinery in motion.-
(1) Where in any factory it becomes necessary to examine any part of
machinery referred to in section 21, while the machinery is in motion,
or, as a result of such examination, to carry out-
 (a) in a case referred to in clause (i) of the proviso to sub-section
(1) of section 21, lubrication or other adjusting operation; or
 (b) in a case referred to in clause (ii) of the proviso aforesaid,
any mounting or shipping of belts or lubrication or other adjusting
operation,
while the machinery is in motion, such - examination or operation
shall be made or carried out only by a specially trained adult male
worker wearing tight fitting clothing (which shall be supplied by the
occupier) whose name has been recorded in the register prescribed in
this behalf and who has been furnished with a certificate of his
appointment, and while he is so engaged,-
 (a) such worker shall not handle a belt at a moving pulley
unless-
o (i) the belt is not more than fifteen centimetres in width;

o (ii) the pulley is normally for the purpose of drive and not
merely a fiy-wheel or balance wheel (in which case belt is not
permissible);
o (iii) the belt joint is either laced or fiush with the belt;
o (iv) the belt, including the joint and the pulley rim, are in
good repair;
o (v) there is reasonable clearance between the pulley and
any fixed plant or structure;
o (vi) secure foothold and, where necessary, secure
handhold, are provided for the operator; and
o (vii) any ladder in use for carrying out any examination or
operation aforesaid is securely fixed or lashed or is firmly held by a
second person ;
 (b) without prejudice to any other provision of this Act relating
to the fencing of machinery, every set screw, bolt and key on any
revolving shaft, spindle, wheel or pinions and all spur, worm and
other toothed or friction gearing in motion with which such worker
would otherwise be liable to come into contact, shall be securely
fenced to prevent such contact.
(2) No woman or young person shall be allowed to clean, lubricate or
adjust any part of a prime-mover or of any transmission machinery
while prime-mover or transmission machinery is in motion, or to
clean, lubricate or adjust any part of any machine if the cleaning,
lubrication or adjustment thereof would expose the woman or young
person to risk of injury from any moving part either of that machine
or of any adjacent machinery.
(3) The State Government may, by notification in the Offlcial Gazette
prohibit, in any specified factory or class or description of factories,
the cleaning, lubricating or adjusting by any person of specified parts
of machinery when those palts are in motion.
Section 23. Employment of young persons on dangerous
machines.-
(1) No young person shall be required or allowed to work at any
machine to which this section applies, unless he has been fully
instructed as to the dangers arising in connection with the machine
and the precautions to be observed, and-

(a) has received sufficient training in work at the machine, or (b) is
under adequate supervision by a person who has a thorough
knowledge and experience of the machine.
(2) Sub-section (1) shall apply to such machines as may be prescribed
by the State Government, being machines which in its opinion are of
such a dangerous character that young persons ought not to work at
them unless the foregoing requirements are complied with.
Section 24. Striking gear and devices for cutting off power.-
 (a) suitable striking gear or other efficient mechanical appliance
shall be provided and maintained and used to move driving belts to
and from fast and loose pulleys wnich form part of the transmission
machinery, and such gear or appliances shall be so constructed,
placed and maintained so as to prevent the belt fiom creeping back on
to the first pulley;
 (b) driving belts whennot in use shall not be allowed to rest or
ride upon shafting in motion.
(2) In every factory suitable devices for cutting off power in
emergencies from running machinerv shall be provided and
maintained in every workroom:
Provided that in respect of factories in operation before the
commencement of this Act, the provisions of this sub-section shall
apply only to workrooms in which electricity is used as power.
(3) When a device, which can inadvertently shift from "off" to "on"
position, is provided in a factory- to cut off power, arrangements shall
be provided for locking the device in safe position to prevent
accidental starting of the transmission machinery or other machines to
which the device it fitted.
Section 25. Self-acting machines.-
No traversing part of a self-acting machine in any factory and no
material carried thereon shall, if the space over which it runs is a
space over which any person is liable to pass, whether in the course of
his employment or otherwise, be allowed to run on its outwards or
inward traverse within a distance forty-five centimetres from any
fixed structure which is not part of the machine:

Provided that the Chief Inspector may permit the continued use of a
machine installed before the commencement of this Act which does
not comply with the requirements of this section on such conditions
for ensuring safety as he may think fit to impose.
Section 26. Casing of new machinery.-
(1) In all machinery driven by power and installed in any factory after
the commencement of this Act,-
 (a) every set screw, bolt or key on any revolving shaft, spindle,
wheel or pinion shall be so sunk, encased or otherwise effectively
guarded as to prevent danger;
 (b) all spur, worm and other toothed or friction gearing which
does not require frequent adjustment while in motion shall be
completely encased, unless it is so situated as to be as safe as it would
be if it were completely encased.
(2) Whoever sells or lets on hire or, agent of a seller or hirer, causes
or procures to be sold or let on hire, for use in a factory any
machinery driven by power which does not comply with the
provisions of sub-section (1) or any rules made under sub-section (3),
shall be punishable with imprisonment for a term which may extend
to three months or with fine which may extend to five hundred rupees
or with both.
(3) The State Government may make rules specifying further
safeguards to be provided in respect of any other dangerous part of
any particular machine or class or description of machines.
Section 27. Prohibition of employment of women and children
near cotton-openers.-
No woman or child shall be employed in any part of a factory for
pressing cotton in which a cotton-opener is at work:
Provided that if the feed-end of a cotton-opener is in a room separated
from the delivery end by a partition extending to the roof or to such
height as the Inspector may in any particular case specify in writing,
women and children may be employed on the side of the partition
where the feed-end is situated.
Section 28. Hoist and lifts.-
 (a) every hoist and lift shall be-

o (i) of good mechanical construction, sound material and
adequate strength;
o (ii) properly maintained, and shall be thoroughly examined
by a competent person at least once in every period of six months, and
a register shall be kept containing the prescribed particulars of every
such examination;
 (b) every hoistway and liftway shall be sufficiently protected by
an enclosure fitted with gates, and the hoist or lift and every such
enclosure shall be so constructed as to prevent any person or thing
from being trapped between any part of the hoist or lift and any fixed
structure or moving part;
 (c) the maximum safe working load shall be plainly marked on
every hoist or lift, and no load greater than such load shall be carried
thereon;
 (d) the cage of every hoist or lift used for carrying persons shall
be fitted with a gate on each side from which access is afforded to a
landing;
 (e) every gate referred to in clause (b) or clause (d) shall be
fitted with inter-locking or other efficient device to secure that the
gate cannot be opened except when the cage is at the landing and that
the cage cannot be moved unless the gate is closed.
(2) The following additional requirements shall apply to hoists and
lifts used for carrying persons and installed or reconstructed in a
factory after the commencement of this Act, namely:-
 (a) where the cage is supported by rope or chain, there shall be
at least two ropes or chains separately connected with the cage and
balance weight, and each rope or chain with its attachments shall be
capable of carrying the whole weight of the cage together with its
maximum load;
 (b) efficient devices shall be provided and maintained capable of
supporting the cage together with its maximum load in the event of
breakage of the ropes, chains or attachments;
 (c) an efficient automatic device shall be provided and
maintained to prevent the cage from over-running.
(3) The Chief Inspector may permit the continued use of a hoist or lift
installed in a factory before the commencement of this Act which

does not fully comply with the provisions of sub-section (1) upon
such conditions for ensuring safety as he may think fit to impose.
(4) The State Government may, if in respect of any class or
description of hoist or lift, is of opinion that it would be unreasonable
to enforce any requirements of sub-sections (1) and (2), by order
direct that such requirement shall not apply to such class or
description of hoist or lift.
Explanation.- For the purposes of this section, no lifting machine or
appliance shall be deemed to be a hoist or lift unless it has a platform
or cage, the direction or movement of which is restricted by a guide or
guides.
Section 29. Lifting machines, chains, ropes and lifting tackles. -
(1) In any factory the following provisions shall be complied with in
respect of every lifting machine (other than a hoist and lift) and every
chain, rope and lifting tackle for the purpose of raising or lowering
persons, goods or materials:-
 (a) all parts, including the working gear, whether fixed or
movable, of every lifting machine and every chain, rope or lifting
tackle shall be-
o (i) of good construction, sound material and adequate
strength and free from defects;
o (ii) properly maintained; and
o (iii) thoroughly examined by a competent person at least
once in every period of twelve months, or at such intervals as the
Chief Inspector may specify in writing, and a register shall be kept
containing the prescribed particulars of every such examination;
 (b) no lifting machine and no chain, rope or lifting tackle shall,
except for the purpose of test, be loaded beyond the safe working load
which shall be plainly marked there on together with an identification
mark and duly entered in the prescribed register; and where this is not
practicable, a table showing the safe working load of every kind and
size of lifting machine or chain, rope of lifting tackle in use, shall be
displayed in prominent position on the premises;
 (c) while any person is employed or working on or near the
wheel track of a travelling crane in any place where he would be
liable to be struck by the crane, effective measures shall be taken to

ensure that the crane does not approach within six metres of that
place.
(2) The State Government may make rules in respect of any lifting
machine or any chain, rope or lifting tackle used in factories-
 (a) prescribing further requirements to be compiled with in
addition to those set out in this section ;
 (b) providing for exemption from compliance with all or any of
the requirements of this section, where in its opinion, such
compliance is unnecessary or impracticable.
(3) For the purposes of this section a lifting machine or a chain, rope
or lifting tackle shall be deemed to have been thoroughly examined if
a visual examination supplemented, if necessary, by other means and
by the dismantling of parts of the gear, has been carried out as
carefully as the conditions permit in order to arrive at a reliable
conclusion as to the safety of the parts examined.
Explanation.- In this section,-
 (a) "lifting machine" means a crane, crab, winch, teagle, pully
block, gin wheel, transporter or runway;
 (b) "lifting tackle" means any chain sling, rope sling, hook,
shackle, swivel, coupling, socket, clamp, tray or similar appliance,
whether fixed or movable, used in connection with the raising or
lowering of persons, or loads by use lifting machines.
Section 30. Revolving machinery. -
(1) In every factory in which the process of grinding is carried on
there shall be permanently affixed to or placed ear each machine in
use a notice indicating the maximum safe working peripheral speed of
every grindstone or abrasive wheel, the speed of the shaft or spindle
upon which the wheel is mounted, and the diameter of the pulley upon
such shaft or spindle necessary to secure such safe working peripheral
speed.
(2) The speeds indicated in notices under sub-section (1) shall not be
exceeded.
(3) Effective measure shall be taken in every factory to ensure that the
safe working peripheral speed of every revolving vessel, cage, basket,
flywheel pulley, disc or similar appliance driven by power is not
exceeded.

Section 31. Pressure plant. -
(1) If in any factory, any plant or machinery or any part thereof is
operated at a pressure above atmospheric pressure, effective measures
shall be taken to ensure that the safe working pressure of such plant or
machinery or part is not exceeded.
(2) The State Government may make rules providing for the
examination and testing of any plant or machinery such as is referred
to in sub-section (1) and prescribing such other safety measures in
relation thereto as may in its opinion, be necessary in any factory or
class or description of factories.
(3) The State Government may, by rules, exempt, subject to such
conditions as may be specified therein, any part of any plant or
machinery referred to in sub-section (1) from the provisions of this
section.
Section 32. Floors, stairs and means of access. -
In every factory-
 (a) all floors, steps, stairs, passengers and gangways shall be of
sound construction, and properly maintained and shall be kept free
from obstructions and substances likely to cause persons to slip and
where it is necessary to ensure safety, steps, stairs, passages and
gangways shall be provided with substantial handrails;
 (b) there shall, so far as is reasonably practicable, be provided,
and maintained safe means of access to every place at which any
person is at any time required to work;
 (c) when any person has to work at a height from where he is
likely to fall, provision shall be made, so far as is reasonably
practicable, by fencing or otherwise, to ensure the safety of the person
so working.
Section 33. Pits, sumps, openings in floors, etc. -
(1) In every factory every fixed vessel, sump, tank, pit or opening in
the ground or in a floor which, by reason of its depth, situation,
construction or contents, is or may be a source of danger, shall be
either securely covered or securely fenced.
(2) The State Government may, by order in writing, exempt, subject
to such conditions as may be prescribed, any factory or class or

description of factories in respect of any vessel, sump, tank, pit or
opening from compliance with the provisions of this section.
Section 34. Excessive weights. -
(1) No person shall be employed in any factory to lift, carry or move
any load so heavy as to be likely to cause him an injury.
(2) The State Government may make rules prescribing the maximum
weights which may be lifted, carried or moved by adult men, adult
women, adolescents and children employed in factories or in any class
or description of factories or in carrying on in any specified process.
Section 35. Protection of eyes. -
In respect of any such manufacturing process carried on in any factory
as may be prescribed, being a process which involves-
 (a) risk of injury to the eyes from particles or fragments thrown
off in the course of the process, or
 (b) risk to the eyes by reason of exposure to excessive light, the
State Government may by rules require that effective screens or
suitable goggles shall be provided for the protection of persons
employed on, or in the immediate vicinity of, the process.
Section 36. Precautions against dangerous fumes, gases, etc.-
(1) No person shall be required or allowed to enter any chamber, tank,
vat, pit, pipe, flue or other confined space in any factory in which any
gas, fume, vapour or dust is likely to be present to such an extent as to
involve risk to persons being overcome thereby, unless it is provided
with a manhole of adequate size or other effective means of egress.
(2) No person shall be required or allowed to enter any confined space
as is referred to in sub-section (1), until all practicable measures have
been taken to remove any gas, fume, vapour or dust, which may be
present so as to bring its level within the permissible limits and to
prevent any ingress of such gas, fume, vapour or dust and unless-
 (a) a certificate in writing has been given by a competent person,
based on a test carried out by himself that the space is reasonably free
from dangerous gas, fume, vapour or dust: or
 (b) such person is wearing suitable breathing apparatus and a
belt securely attached to a rope the free end of which is held by a
person outside the confined space.

Section 36A. Precautions regarding the use of portable electric
light.-
In any factory-
 (a) no portable electric light or any other electric appliance of
voltage exceeding twenty-four volts shall be permitted for use inside
any chamber, tank, vat, pit, pipe, flue or other confined space unless
adequate safety devices are provided; and
 (b) if any inflammable gas, fume or dust is likely to be present
in such chambers tank, vat, pipe, flue or other confined space, no
lamp or light other than that of flame-proof construction shall be
permitted to be used therein.
Section 37. Explosive or inflammable dust, gas, etc. -
Where in any factory any manufacturing process produces dust, gas,
fume or vapour of such character and to such extent as to be likely to
explode on ignition, all practicable measures shall be taken to prevent
any such explosion by-
 (a) effective enclosure of the plant or machinery used in the
process;
 (b) removal or prevention of the accumulation of such dust, gas,
fume or vapour;
 (c) exclusion or effective enclosure of all possible sources of
ignition.
(2) Where in any factory the plant or machinery used in a process
such as is referred to in sub-section (1), is not so constructed as to
withstand the probable pressure which such an explosion as aforesaid
would produce, all practicable measures shall be taken to restrict the
spread and effects of the explosion by the provision in the plant or
machinery of chokes, baffles, vents or other effective appliances.
(3) Where any part of the plant or machinery in a factory contains any
explosive or inflammable gas or vapour under pressure greater than
atmospheric pressure, that part shall not be opened except in
accordance with the following provisions, namely:-
 (a) before the fastening of any joint of any pipe connected with
the part or the fastening of the cover of any opening into the part is
loosened, any flow of the gas or vapour into the part of any such pipe
shall be effectively stopped by a stop-valve or other means;

 (b) before any such fastening as aforesaid is removed, all
practicable measures shall be taken to reduce the pressure of the gas
or vapour in the part or pipe to a atmospheric pressure;
 (c) where any such fastening as aforesaid has been loosened or
removed effective measures shall be taken to prevent any explosive or
inflammable gas or vapour from entering the part or pipe until the
fastening has been secured, or, as the case may be, securely replaced:
Provided that the provisions of this sub-section shall not apply in the
case of plant or machinery installed in the open air.
(4) No plant, tank or vessel which contains or has contained any
explosive or inflammable substance shall be subjected, in any factory,
to any welding, brazing, soldering or cutting operation which involves
the application of heat unless adequate measures have first been taken
to remove such substance and any fumes arising therefrom or to
render such substance and fumes non- explosive or non-inflammable
and no such substance shall be allowed to enter such plant, tank or
vessel after any such operation until the metal has cooled sufficiently
to prevent any risk of igniting the substance.
(5) The State Government may by rules exempt, subject to such
conditions as may be prescribed, any factory or class or description of
factories from compliance with all or any of the provisions of this
section.
Section 38. Precautions in case of fire. -
(1) In every factory, all practicable measures shall be taken to prevent
outbreak of fire and its spread, both internally and externally, and to
provide and maintain-
 (a) safe means of escape for all persons in the event of a fire,
and
 (b) the necessary equipment and facilities for extinguishing fire.
(2) Effective measures shall be taken to ensure that in every factory
all the workers are familiar with the means of escape in case of fire
and have been adequately trained in the routine to be following in
such cases.
(3) The State Government may make rules, in respect of any factory
or class or description of factories, requiring the measures to be
adopted to give effect to the provisions of sub-sections (1) and (2).

(4) Notwithstanding anything contained in clause (a) of sub-section
(1) or sub-section (2), if the Chief Inspector, having regard to the
nature of the work carried on in any factory, the construction of such
factory, special risk to life or safety, or any other circumstances, is of
the opinion that the measures provided in the factory, whether as
prescribed or not, for the purposes of clause (a) of sub-section (1) or
sub-section (2), are inadequate, he may, by order in writing, require
that such additional measures as he may consider reasonable and
necessary, be provided in the factory before such date as is specified
in the order.
Section 39. Power to require specifications of defective parts or
tests of stability. -
If it appears to the Inspector that any building or part of a building or
any part of the ways, machinery or plant in a factory is in such a
condition that it may be dangerous to human life or safety, he may
serve on the occupier or manager or both of the factory an order in
writing requiring him before a specified date-
 (a) to furnish such drawings, specifications and other particulars
as may be necessary to determine whether such buildings, ways,
machinery or plant can be used with safety, or
 (b) to carry out such tests in such manner as may be specified in
the order, and to inform the Inspector of the results thereof.
Section 40. Safety of buildings and machinery. -
(1) If it appears to the Inspector that any building or part of a building
or any part of the ways, machinery or plant in a factory is in such a
condition that it is dangerous to human life or safety, he may serve on
the occupier or manager or both of the factory an order in writing
specifying the measures, which in his opinion should be adopted and
requiring them to be carried out before a specified date.
(2) If it appears to the Inspector that the use of any building or part of
a building or any part of the ways, machinery or plant in a factory
involves imminent danger to human life or safety he may serve on the
occupier or manager or both of the factory an order in writing
prohibiting its use until it has been properly repaired or altered.
Section 40A. Maintenance of buildings. -

If it appears to the Inspector that any building or part of a building in
a factory is in such a state of disrepair as is likely to lead to conditions
detrimental to the health and welfare of the workers, he may serve on
the occupier or manager or both of the factory an order in writing
specifying the measures which in his opinion should be taken and
requiring the same to be carried out before such date as is specified in
the order.
Section 40B. Safety Officers. -
 (i) wherein one thousand or more workers are ordinarily
employed, or
 (ii) wherein, in the opinion of the State Government, any
manufacturing process or operation is carried on, which process or
operation involves any risk of bodily injury, poisoning or disease or
any other hazard to health, to the person employed in the factory,
the occupier shall, if so required by the State Government by
notification in Official Gazette, employ such number of Safety
Officers as may be specified in that notification.
(2) The duties, qualifications and conditions of service of Safety
Officers shall be such as may be prescribed by the State Government.
Section 41. Power to make rules to supplement this Chapter. -
The State Government may make rules requiring the provision in any
factory or in any class or description of factories of such further
devices and measures for securing safety of persons employed therein
as it may deem necessary.
SOCIAL SECURITY
Introduction
The concept of social security arose from diverse difficulties
humanity faced and the quest for protection against vast “human”
adversaries in life and in work within the walls of the 21st century.
After the industrial revolution in Europe, a new class of “workers”
emerged. Disconnected from their families and villages they were
completely dependent on their wages. As human’s advanced,
comprehensive social security systems were developed covering all
events, from birth till death and pre-natal and maternity benifits, paid

leave, medical care, pensions, unemployment benefits, family
allowances and old age pensions, etc.
Meaning:-Social security refers to protection provided by the society
to its members against providential mishaps over which a person has
no control. The underlying philosophy of social security is that the
State shall make itself responsible for ensuring a minimum standard
of material welfare to all its citizens on a basis wide enough to cover
all the main contingencies of life. In other sense, social security is
primarily an instrument of social and economic justice.
Definitions of social security:
According to a definition given in the ILO publication’, “Social
security is the security that society furnishes through appropriate
organisation against certain risks to which its members are exposed.
These risks are essentially contingencies of life which the individual
of small means cannot effectively provide by his own ability, or
foresight alone or even in private combination with his fellows”.
William Beveridge has defined social security as “a means of
securing an income to take the place of earnings when they are
interrupted by unemployment, sickness or accident to provide for the
retirement through old age, to provide against loss of support by death
of another person or to meet exceptional expenditure connected with
birth, death, or marriage. The purpose of social security is to provide
an income up to a minimum and also medical treatment to bring the
interruption of earnings to an end as soon as possible.”
Objectives of Social Security:
The objectives of social security can be sub-summed under three,
categories:
1. Compensation
2. Restoration
3. Prevention
A brief description of these is given as under:
Compensation:
Compensation ensures security of income. It is based on this
consideration that during the period of contingency of risks, the
individual and his/her family should not be subjected to a double
calamity, i.e., destitution and loss of health, limb, life or work.

Restoration:
It connotates cure of one’s sickness, reemployment so as to restore
him/her to earlier condition. In a sense, it is an extension of
compensation.
Prevention:
These measures imply to avoid the loss of productive capacity due to
sickness, unemployment or invalidity to earn income. In other words,
these measures are designed with an objective to increase the
material, intellectual and moral well-being of the community by
rendering available resources which are used up by avoidable disease
and idleness.
Scope of social security:-
The term ‘social security’ is all embracing. The scope of social
security is, therefore, very wide. It covers the aspects relating to social
and economic justice.
All social security schemes furnished by the government are
broadly classified into two types:
(i) Social Assistance, and
(ii) Social Insurance.
According to the Social Security (Minimum Standards)
Convention (No. 102) adopted by the ILO in 1952, the following
are the nine components of social security that configure its
scope:
(i) Medical care,
(ii) Sickness benefit,
(iii) Unemployment benefit.
(iv) Old age benefit,
(v) Employment injury benefit,
(vi) Family benefit,
(vii) Maternity benefit,
(viii) Invalidity benefit, and
(ix) Survivor’s benefit
Need for Social Security:
One moot question to be answered is why there is a need for social
security especially in India. As has already been mentioned, the
underlying philosophy of social security is to ensure a minimum level

of material living to the needy or helpless ones of the society by the
State.
Our accumulated experience reveals that in an industrial economy, the
workers have been subjected to periodic unemployment due to
cyclical fluctuations in business, sickness, industrial accidents and old
age. In fact, there is nothing more disconcerting to worker and his/her
family than unemployment.
Similarly, while sickness suspends earning capacity of a worker
temporarily, industrial accidents may disable him/her partially or even
permanently, and old age may put a stop to his/her ability to earn and
support himself/herself and the family. The capitalist having sufficient
resources have no problem in facing such risks of life. But, the worker
does not have resources required to face the risks caused by sickness,
accidents, unemployment and old age.
Nor has he/she alternative sources of livelihood or accumulated
property to overcome the period of adversity. Such a situation
underlines the need for social security to be provided to such needy
workers/people. Naturally, the Government has, then, the obligation
to help the needy and helpless workers and provide them security to
pass through in period of adversity.
That the need for social security is realized not only to afford the
needy workers’ protection against the adversities of life, but also for
the overall development of the State is well elucidated by a former
veteran trade union leader, the President of India, Mr. V.V. Giri. He
opines that, “Social security measures have two-told significance for
every developing country.
They constitute an important step toward the goal of a Welfare State,
by improving living and working conditions and affording the people
protection against the uncertainties of the future. These measures are
also important for every industrialisationprogramme, for not only to
enable workers to become more efficient but they also reduce the
wastage arising from industrial disputes.
The man-days lost on account of sickness and disability also
constitute a heavy drain on the slender resources of the worker and on
the industrial output of the country. Lack of social security impedes
production and prevents the formation of a stable and efficient labour

force. Social security is, therefore, not a burden, but a wise investment
in the long run.”
Thus, the need for a comprehensive programme of social security in
India is so strong that it needs no more proof or evidence. It is must to
ensure a minimum level of living for those who are helpless on
various counts
Social securely act’s in India
The issue of Social Security in India have been addressed by the
Central Government through various Acts:
1. Workmen's Compensation Act, 1923;
2. Maternity Benefit Act, 1961;
3. Employment State Insurance Scheme, 1948;
4. Employment Provident Fund Scheme, 1925;
5. Coal Mines Provident Fund Bonus Scheme, 1948;
6. Employees Provident Fund Act, 1952;
7. Employees Family Pension Scheme, 1971;
8. The Assam Tea Plantation Provident Fund Act, 1965;
9. The Seamen's Provident Fund Act, 1966;
10. Safety Health and Welfare of Dock Workers (The Dock
Workers Regulation of Employment Act, 1948);
11. The Survivor-ship Pension Scheme, 1971;
12. The Lay-off and Retrenchment Compensation (Industrial
Dispute Act, 1947 with amendment in 1953);
13. The Old Age Pension Scheme (The Family Pension Scheme,
1964);
14. Gratuity Trust Funds;
15. Unemployment Insurance;
16. Integrated Social Security Scheme.
The schemes mentioned above, have been discussed and amended by
the government of India from time to time. Many more schemes are
being discussed today. The government is trying to cover aspects such
as environment, habitat, health and nutrition in a larger space of social
security. Extending schemes for the formal sector into the informal
sector would bring quite instability in many formal and informal
groups. This expands the need to address both the formal and the

informal sector, rather implementing same policies for both the
groups.
JOB STRESS: Job stress can be defined as the harmful physical and
emotional responses that occur when the requirements of the job do
not match the capabilities, resources, or needs of the worker. Job
stress can lead to poor health and even injury.The concept of job
stress is often confused with challenge, but these concepts are not the
same. Challenge energizes us psychologically and physically, and it
motivates us to learn new skills and master our jobs. When a
challenge is met, we feel relaxed and satisfied. Thus, challenge is an
important ingredient for healthy and productive work. The importance
of challenge in our work lives is probably what people are referring to
when they say "a little bit of stress is good for you.
Stress Can Be Positive or Negative
Many people think stress, by definition, is a negative thing that they
should attempt to avoid at all times. This myth is very common, but it
is untrue. While too much stress can be detrimental to physical and
mental well being, there are situations in which stress - managed
effectively - can act ually be beneficial.
While an approaching deadline can be described as a stressor, it's
positive for some people and negative for others. Many people do
their best work when they have a limited time to complete what
they're doing, while others aren't able to cope with the pressure of an
approaching deadline. Those who react negatively to impending
deadlines tend to refer to them as stressful, while those who work well
under pressure often describe them as motivators.
What causes job stress?
Most of the time, it's the major sources of stress that lead to job
burnout and health problems. Job stress can affect your home life too.
Here are some common sources of major job stress, with examples of
each:
 Lack of control. Feeling as if you have no control over your
work or job duties is the biggest cause of job stress. People who feel
like they have no control at work are most likely to get stress-related
illnesses. Here's an example:

Shelly is responsible for putting together a report that her boss must
deliver at a 4 p.m. meeting. She's been waiting all day for the notes
and numbers she needs. Shelly finally gets the notes from her boss at
3:15 and rushes to prepare the report and charts and to make copies in
time. She gets it done, but she feels mad and resentful. This is the
third time this week that this has happened.
 Increased responsibility. Taking on extra duties in your job is
stressful. You can get more stressed if you have too much work to do
and you can't say no to new tasks.
John volunteers for every new project, because he heard that's the best
way to get promoted. But the tasks are starting to pile up, and he's
feeling overwhelmed. He knows he can't really manage one more
thing. But this morning, John's boss asked him to take on another
project, and John agreed. Now he's more worried than ever about
getting everything done.
 Job satisfaction and performance. Do you take pride in your
job? If your job isn't meaningful, you may find it stressful. Are you
worried about doing well at work? Feeling insecure about job
performance is a major source of stress for many people.
Raoul has worked in his new job for 8 months. He thinks he is doing
well. But his boss doesn't say much, so Raoul isn't sure. He wonders if
he's on the right track, but he's afraid to ask.
 Uncertainty about work roles. Being unsure about your duties,
how your job might be changing, or the goals of your department or
company can lead to stress. If you report to more than one boss,
juggling the demands of different managers can also be stressful.
Rosa's old manager was promoted. Now Rosa is working for someone
new. She's heard that the new boss plans to "shake things up" in her
department. The new boss just hired Emily, whose job seems to be the
same as Rosa's. Rosa worries about what this means for her.
 Poor communication. Tension on the job often comes from
poor communication. Being unable to talk about your needs,
concerns, and frustrations can create stress.
A new job with more responsibility and better pay just opened up in
Jill's department. Jill knows she can do this job. And she's been with
the company longer than anyone else on her team. She waits for her

manager to ask if she is interested. But after several weeks, a
coworker is promoted to the new job. Jill feels hurt and angry, but she
doesn't say anything.
 Lack of support. Lack of support from your boss or coworkers
makes it harder to solve other problems at work that are causing stress
for you.
Jeff works in a busy office answering customer complaint calls all
day. It would be easier to handle all the calls if he could at least trade
tips with his coworkers. But everyone else is busy too. His coworkers
never make it out of their cubicles during the day, even to let off a
little steam.
 Poor working conditions. Unpleasant or dangerous physical
conditions, such as crowding, noise, or ergonomic problems, can
cause stress.
Multiple Sources of Work Stress

 Environmental Stress - Some stress that people experience in
the workplace is related to the physical environment in which they
work. This type of stress can be associated with workplace safety
issues, the configuration of one's work area, the type of furniture or
equipment that must be used in order to perform job functions, and
other variables.
 Uncertainty - People who aren't sure where they stand in their
jobs often experience a high degree of work stress. This issue can be
tied to fear of job loss, hoping for recognition or a promotion, a lack
of feedback on one's performance, or other issues.
 People Issues - A great deal of workplace stress is related to
people problems, such as coping with difficult co-workers, dealing
with a negative or uncommunicative supervisor, peer pressure, and
more.
 Performance Pressure- Feeling pressure to produce a certain
quality or quantity of work can be a workplace stressor. This can be
tied to sales or production quotas, manufacturing standards,
impending deadlines, and other factors.
JOB EVALUATION

Job evaluation is the process of analyzing and assessing various jobs
systematically to ascertain their relative worth in an organization.
Job evaluation is an assessment of the relative worth of various jobs
on the basis of a consistent set of job and personal factors, such as
qualifications and skills required
DEFINITION:-
In the words of Edwin B. Flippo. "Job evaluation is a systematic and
orderly process of determining the worth of a job in relation to other
jobs."
According to Kimball and Kimball Jr., "Job evaluation represents
an effort to determine the relative value of every job in a plant and to
determine what the fair basic wage for such a job should be."
According to Bethel, Atwater and Smith et at, "Job evaluation as a
personal term has both a specific and genetic meaning specifically, it
means job rating or the grading of occupations in terms of duties ;
generally it means the entire field of wages and salary administration
along modern lines"
According to International Labour Organisation, "Job evaluation
may be defined as an attempt to determine and compare the demands
which the normal performance of particular job makes on normal
workers without taking account of the individual abilities or
performance of the workers concerned."
THE JOB EVALUATION PROCESS
Job analysis describes a job. Job evaluation develops a plan for
comparing jobs in terms of those things the organization considers
important determinants of job worth. This process involves a number
of steps that will be briefly stated here and then discussed more fully.
1. Job Analysis. The first step is a study of the jobs in the
organization. Through job analysis, information on job content is
obtained, together with an appreciation of worker requirements for
successful performance of the job. This information is recorded in the
precise, consistent language of a job description. This was the topic of
chapter 10.
2. Compensable Factors. The next step is deciding what the
organization "is paying for" -- that is, what factor or factors place one
job at a higher level in the job hierarchy than another. These

compensable factors are the yardsticks used to determine the relative
position of jobs. In a sense, choosing compensable factors is the heart
of job evaluation. Not only do these factors place jobs in the
organization's job hierarchy, but they also serve to inform job
incumbents which contributions are rewarded.
3. Developing the Method. The third step in job evaluation is to
select a method of appraising the organization's jobs according to the
factor(s) chosen. The method should permit consistent placement of
the organization's jobs containing more of the factors higher in the job
hierarchy, than those jobs lower in the hierarchy.
4. Job Structure. The fourth step is comparing jobs to develop a
job structure. This involves choosing and assigning decision makers,
reaching and recording decisions, and setting up the job hierarchy.
5. Wage Structure. The final step is pricing the job structure to
arrive at a wage structure.
Features of Job Evaluation
The primary objective of job evaluation is to find out the value of
work, but this is a value which varies from time to time and from
place to place under the influence of certain economic pressure, not
least of which is the worth of money itself. The main features of job
evaluations are:
1. To supply bases for wage negotiation founded on facts rather
than on vague intermediate ideas.
2. It attempts to assess jobs, not people.
3. Job evaluation is the output provided by job analysis.
4. Job evaluation does not design wage structure, it helps in
rationalising the system by reducing number of separate and different
rates.
5. Job evaluation is not made by individuals rather it is done by
group of experts.
6. Job evaluation determines the value of job. Further the value of
each of the aspects such as skill and responsibility levels are also
related and studied in connection with the job.
7. Job evaluation helps the management to maintain high levels of
employee productivity and employee satisfaction.
The objectives of job evaluation

1. To establish an orderly, rational, systematic structure of jobs
based on their worth to the organization.
2. To justify an existing pay rate structure or to develop one that
provides for internal equity.
3. To assist in setting pay rates that are comparable to those of in
similar jobs in other organizations to compete in market place for best
talent.
4. To provide a rational basis for negotiating pay rates when
bargaining collectively with a recognized union.
5. To ensure the fair and equitable compensation of employees in
relation to their duties.
6. To ensure equity in pay for jobs of similar skill, effort,
responsibility and working conditions by using a system that
consistently and accurately assesses differences in relative value
among jobs and
7. To establish a framework of procedures to determine the grade
levels and the consequent salary range for new jobs or jobs which
have evolved and changed.
8. To identify a ladder of progression for future movement to all
employees interested in improving their compensation.
9. To comply with equal pay legislation and regulations
determining pay differences according to job content.
10. To develop a base for merit or pay-for-performance.
Advantages of Job evaluation
Job evaluation is a process of determining the relative worth of a job.
It is a process which is helpful even for framing compensation plans
by the personnel manager. Job evaluation as a process is
advantageous to a company in many ways:
1. Reduction in inequalities in salary structure - It is found that
people and their motivation is dependent upon how well they are
being paid. Therefore the main objective of job evaluation is to have
external and internal consistency in salary structure so that
inequalities in salaries are reduced.
2. Specialization - Because of division of labour and thereby
specialization, a large number of enterprises have got hundred jobs
and many employees to perform them. Therefore, an attempt should

be made to define a job and thereby fix salaries for it. This is possible
only through job evaluation.
3. Helps in selection of employees - The job evaluation
information can be helpful at the time of selection of candidates. The
factors that are determined for job evaluation can be taken into
account while selecting the employees.
4. Harmonious relationship between employees and manager -
Through job evaluation, harmonious and congenial relations can be
maintained between employees and management, so that all kinds of
salaries controversies can be minimized.
5. Standardization - The process of determining the salary
differentials for different jobs become standardized through job
evaluation. This helps in bringing uniformity into salary structure.
6. Relevance of new jobs - Through job evaluation, one can
understand the relative value of new jobs in a concern.
Limitations:
1. Though there are many ways of applying job evaluation in a
flexible manner, rapid changes in technology and in the supply of and
demand for particular skills, create problems of adjustment that may
need further study.
2. When job evaluation results in substantial changes in the
existing wage structure, the possibility of implementing these changes
in a relatively short period may be restricted by the financial limits
within which the firm has to operate.
3. When there are a large proportion of incentive workers, it may
be difficult to maintain a reasonable and acceptable structure of
relative earnings.
4. The process of job rating is, to some extent, inexact because
some of the factors and degrees can be measured with accuracy.
5. Job evaluation takes a long time to complete, requires
specialized technical personnel and isquite expensive.
JOB EVALUATION METHODS
There are four basic methods of job evaluation currently in use
which are grouped into two categories:
1. Non-quantitative Methods:
(a) Ranking or Job Comparison

(b) Grading or Job Classification
2. Quantitative Methods:
(a) Point Rating
(b) Factor Comparison
Ranking Method:
The ranking method is the simplest form of job evaluation. In this
method, each job as a whole is compared with other and this
comparison of jobs goes on until all the jobs have been evaluated and
ranked. All jobs are ranked in the order of their importance from the
simplest to the hardest or from the highest to the lowest.
The importance of order of job is judged in terms of duties,
responsibilities and demands on the job holder. The jobs are ranked
according to “the whole job” rather than a number of compensable
factors. The ranking of jobs in a University, based on Ranking
Method, may be like this:
The application of the Ranking Method involves the following
procedure:
1. Analyse and describe jobs, bringing out those aspects which are to
be used for purpose of job comparison.
2. Identify bench-mark jobs (10 to 20 jobs, which include all major
departments and functions). The jobs may be the most and least
important jobs, a job midway between the two extremes, and others at
the higher or lower intermediate points.
3. Rank all jobs in the organisation around the bench-mark jobs until
all jobs are placed in their rank order of importance.
4. Finally, divide all the ranked jobs into appropriate groups or
classifications by considering the common features of jobs such as
similar duties, skills or training requirements. All the jobs within a
particular group or classification receive the same wage or range of
rates.
Ranking method is appropriate for small-size organisations where
jobs are simple and few. It is also suitable for evaluating managerial
jobs wherein job contents cannot be measured in quantitative terms.
Ranking method being simple one can be used in the initial stages of
job evaluation in an organisation.
Merits:

Ranking method has the following merits:
1. It is the simplest method.
2. It is quite economical to put it into effect.
3. It is less time consuming and involves little paper work.
Demerits:
The method suffers from the following demerits:
1. The main demerit of the ranking method is that there are no definite
standards of judgment and also there is no way of measuring the
differences between jobs.
2. It suffers from its sheer unmanageability when there are a large
number of jobs.
Grading Method:
Grading method is also known as ‘classification method’. This
method of job evaluation was made popular by the U.S. Civil Service
Commission. Under this method, job grades or classes are established
by an authorised body or committee appointed for this purpose. A job
grade is defined as a group of different jobs of similar difficulty or
requiring similar skills to perform them. Job grades are determined on
the basis of information derived from job analysis.
The grades or classes are created by identifying some common
denominator such as skills, knowledge and responsibilities. The
example of job grades may include, depending on the type of jobs the
organisation offers, skilled, unskilled, account clerk, clerk-cum-typist,
steno typist, office superintendent, laboratory assistant and so on.
Once the grades are established, each job is then placed into its
appropriate grade or class depending on how well its characteristics
fit in a grade. In this way, a series of job grades is created. Then,
different wage/salary rate is fixed for each grade.
Merits:
The main merits of grading method of job evaluation are:
1. This method is easy to understand and simple to operate.
2. It is economical and, therefore, suitable for small organisations.
3. The grouping of jobs into classifications makes pay determination
problems easy to administer.
4. This method is useful for Government jobs.
Demerits:

The demerits of this method include:
1. The method suffers from personal bias of the committee members.
2. It cannot deal with complex jobs which will not fit neatly into one
grade.
3. This method is rarely used in an industry.
Points Rating:
This is the most widely used method of job evaluation. Under this
method, jobs are broke down based on various identifiable factors
such as skill, effort, training, knowledge, hazards, responsibility, etc.
Thereafter, points are allocated to each of these factors.
Weights are given to factors depending on their importance to
perform the job. Points so allocated to various factors of a job are then
summed. Then, the jobs with similar total of points are placed in
similar pay grades. The sum of points gives an index of the relative
significance of the jobs that are rated.
The procedure involved in determining job points is as follows:
Determine the jobs to be evaluated. Jobs should cover all the major
occupational and levels of responsibility to be covered by the method.
Decide on the factors to be used in analysing and evaluating the jobs.
The number of factors needs to be restricted because too many factors
result in an over-complex scheme with overlap and duplication
between factors.
Define the factors clearly in written. This is necessary to ensure that
different job raters interpret a particular factor in the same sense.
Determine degrees of each factor and assign point value to each
degree.
Point values are assigned to different degrees on the basis of
arithmetic progression.
Finally, money values are assigned to points. For this purpose, points
are added to give the total value of a job. Its value is then translated
into money terms with a predetermined formula.
Merits:
The method has the following merits:
1. It is the most comprehensive and accurate method of job
evaluation.

2. Prejudice and human judgment are minimised, i.e. the system
cannot be easily manipulated.
3. Being the systematic method, workers of the organisationfavour
this method.
4. The scales developed in this method can be used for long time.
5. Jobs can be easily placed in distinct categories.
Demerits:
The drawbacks of the method are:
1. It is both time-consuming and expensive method.
2. It is difficult to understand for an average worker.
3. A lot of clerical work is involved in recording rating scales.
4. It is not suitable for managerial jobs wherein the work content is
not measurable in quantitative terms.
Factor Comparison Method:
This method is a combination of both ranking and point methods in
the sense that it rates jobs by comparing them and makes analysis by
breaking jobs into compensable factors. This system is usually used to
evaluate white collar, professional and managerial positions.
The mechanism for evaluating jobs under this method involves
the following steps:
1. First of all, the key or benchmark jobs are selected as standards.
The key jobs selected should have standards contents, well accepted
pay rates in the community, and should consist of a representative
cross-section of all jobs that are being evaluated-from the lowest to
the highest paid job, from the most important to the least important—
and cover the full range of requirements of each factor, as agreed
upon by a Committee representing workers and management.
2. The factors common to all jobs are identified, selected and defined
precisely. The common factors to all jobs are usually five, viz., mental
requirements, physical requirements, skill requirements, working
conditions and responsibility.
3. Once the key jobs are identified and also the common factors are
chosen, the key jobs are, then, ranked in terms of the selected
common factors.
4. The next step is to determine a fair and equitable base rate (usually
expressed on an hourly basis) and, then, allocate this base rate among

the five common factors as mentioned earlier. Following is a
specimen of base rate and its allocation scheme:
5. The
final step in factor comparison method is to compare and evaluate the
remaining jobs in the organisation. To illustrate, a ‘toolmaker’ job is
to be evaluated. After comparison, it is found that its skill is similar to
electrician (5), mental requirements to welder (10) Physical
requirements to again electrician (12), working conditions to mecha-
nist (24) and responsibility also to mechanist (3). Thus, the wage rate
for the job of toolmaker will be Rs. 54 (Rs.5 + Rs. 10 + Rs. 12 +
Rs.24 + Rs.3).
Merits:
This method enjoys the following merits:
1. It is more objective method of job evaluation.
2. The method is flexible as there is no upper limit on the rating of a
factor.
3. It is fairly easy method to explain to employees.
4. The use of limited number of factors (usually five) ensures less
chances of overlapping and over-weighting of factors.
5. It facilitates determining the relative worth of different jobs.
Demerits:
The method, however, suffers from the following drawbacks:
1. It is expensive and time-consuming method.
2. Using the same five factors for evaluating jobs may not always be
appropriate because jobs differ across and within organizations.
3. It is difficult to understand and operate
QUALITY CIRCLES
A quality circle is a volunteer group composed of workers , usually
under the leadership of their supervisor , who are trained to identify,
analyze and solve work-related problems and present their solutions
to management in order to improve the performance of the

organization, and motivate and enrich the work of employees. When
matured, true quality circles become self-managing, having gained the
confidence of management.
It is a work group of employees who meet regularly to discuss their
quality problems, investigate causes, recommend solutions, and take
corrective actions. Generally, QC is a small group of employees
belonging to the same similar work area. This is so because the
employees doing the similar type of work are well familiar to
problems faced by them. The size of the QC should not be too big so
as to prevent some members from participating meaningfully in its
meetings. Generally, six to eight members are considered the ideal
size of the QC.
Definition:
Perhaps the most widely discussed and undertaken intervention of
employee involvement is the quality circle (QC). The concept of QC
originally began in the United States and was exported to Japan in the
1950s. It is mentioned that it is the concept of QC that enabled
Japanese firms to make high quality products at low costs
OBJECTIVES
1. To contribute towards the improvement and development of the
organization or a department.
2. To overcome the barriers that may exist within the prevailing
organizational structure so as to foster an open exchange of ideas.
3. To develop a positive attitude and feel a sense of involvement in
the decision making processes of the services offered.
4. To respect humanity and to build a happy work place
worthwhile to work.
5. To display human capabilities totally and in a long run to draw
out the infinite possibilities.
6. To improve the quality of products and services.
7. To improve competence, which is one of the goals of all
organizations.
8. To reduce cost and redundant efforts in the long run.
9. With improved efficiency, the lead time on convene of
information and its subassemblies is reduced, resulting in an
improvement in meeting customers due dates.

10. Customer satisfaction is the fundamental goal of any library. It
will ultimately be achieved by Quality Circle and will also help to be
competitive for a long time
The main features of QC:
1. Voluntary Groups:
QC is a voluntary group of employees generally coming from the
same work area. There is no pressure from anywhere on employees to
join QC.
2. Small Size:
The size of the QC is generally small consisting of six to eight
members.
3. Regular Meeting:
QC meetings are held once a week for about an hour on regular basis.
The members meet during working hours usually at the end of the
working day in consultation with the manager. The time of the
meetings is usually fixed in advance in consultation with the manager
and members.
4. Independent Agenda:
Each QC has its own agenda with its own terms of reference.
Accordingly, each QC discusses its own problems and takes
corrective actions.
5. Quality Focused:
As per the very nature and intent of QC, it focuses exclusively on
quality issues. This is because the ultimate purpose of QC is
improvement in quality of product and working life.
Developing Quality Circles in Organisations:
Like any other organizational change, QC being a new concept may
be opposed by the employees.
Therefore, QC should be developed and introduced with great
concern and precaution as discussed below:
1. Publicising the Idea:
Introduction of QC is just like an organisational change programme
Hence, like an organisational change programme, the workers need to
be convinced about the need for and significance of QC from the
points of view of the workers and the organisation. Moreover,
participation in QC being voluntary, its publicity among the workers

is necessary. To begin with, management can also arrange for initial
training to those workers who want to form a quality circle.
2. Constitution of QC:
Workers doing the same or similar type of work are drawn voluntarily
to form quality circle. The membership of a QC is generally restricted
to eight to ten. Once a QC is formed, they remain as permanent
members of the circle unless they leave that work area.
3. Initial Problem Solving:
The members of QC should discuss the problem at threadbare and,
then, prepare a list of alternative solutions. Thereafter, each
alternative solution should be evaluated and the final solution should
be arrived at on the basis of consensus.
4. Presentation and Approval of Suggestions:
The final solution arrived at should be presented to the management
either in oral or in written form. The management may evaluate the
solution by constituting a committee for this purpose. The committee
may also meet the members of the quality circle for clarifications, if
required. Presentation of solutions to the management helps improve
the communication between management and workers and reflects
management’s interest to the members of QC.
5. Implementation:
Once the suggestion or solution is approved by the management, the
same is being put into practice in a particular workplace. Quality
circles may be organized gradually for other workplaces or
departments also. In this way, following above outlined process, the
entire organisation can have quality circles.
BENEFITS OF QUALITY CIRCLE:-
 Self-development: QC’s assist self-development of members by
improving self-confidence, attitudinal change, and a sense of
accomplishment.
 Social development: QC is a consultative and participative
programme where every member cooperates with others. This
interaction assists in developing harmony.
 Opportunity to attain knowledge:QC members have a chance
for attaining new knowledge by sharing opinions, thoughts, and
experience.

 Potential Leader: Every member gets a chance to build up his
leadership potential, in view of the fact that any member can become
a leader.
 Enhanced communication skills:The mutual problem solving
and presentation before the management assists the members to
develop their communication skills.
 Job-satisfaction: QC’s promote creativity by tapping the
undeveloped intellectual skills of the individual. Individuals in
addition execute activities diverse from regular work, which enhances
their self-confidence and gives them huge job satisfaction.
 Healthy work environment: QC’s creates a tension-free
atmosphere, which each individual likes, understands, and co-operates
with others.
 Organizational benefits: The individual benefits create a
synergistic effect, leading to cost effectiveness, reduction in waste,
better quality, and higher productivity.
QUALITY CIRCLE IN INDIA
The concept of quality circle which was originated in the United
States and actually proliferated in Japan is of recent origin in India. In
India, by now several companies have implemented QC programmes.
Companies where the QC programmes have been working
successfully include BHEL, Kirloskar Oil Engines, Mahindra &
Mahindra, Bajaj Auto, HMT, Maruti, Modi Xerox. SBI, Hindustan
Aluminum, Modi Rubber, TELCO, LUCAS-TVS, etc.
In an attempt to make the QCs as movement, the successful cases of
QC implementation are published by the Quality Forum of India
through its journal, namely, ‘Quality Circle India’.
Following this, an increasing number of companies in India have also
been publishing QC cases in their in house magazines and newsletters
to disseminate their quality circle experiences across the country. As
such, QC as a campaign has gained momentum and more and more
companies are coming forward to implement QC programmes to
improve the quality of their products and working life conditions as
well.

Problems of Quality Circles and Their Solutions:
Though QC concept has many positive points, it has failed miserably
in many organisations due to certain problems and pitfalls. Following
are some important problems of QC implementation in India and
remedies to overcome or solve them.
1. Negative Attitude:
Both employees and managers having negative attitude toward QC
often resist its implementation. Managers feel that QC dilutes their
authority and importance in the organisation. This negative attitude
can be dispelled by imparting appropriate training to employees as
well managers about the real concept and contribution of QC.
2. Lack of Ability:
The Indian workers are characterized by their low level of educations
and also lack of leadership qualities. This problem can be overcome
by initiating workers’ education programme.
3. Lack of Management Commitment:
Lack of management commitment toward QC is demonstrated by not
permitting the members to hold QC meetings during the working
hours. Therefore, the top management should permit the members to
hold QC meetings periodically during working hours preferably at the
end of the day. Management should also extend all required and
timely assistance for the smooth functioning of QC.
4. Non-implementation of Suggestions:
The members of the QC feel disheartened in case their suggestions are
not accepted and implemented by the management without giving
convincing reasons for not doing so. Instead, the suggestions rendered
by QC should be given due consideration and weightage and should
be implemented honestly.
This will, as a result, further enthuse, the members of QC to improve
quality of their goods and services. In this way, QC may benefit both
workers and organisation. In other worlds, QC is symbiotic for
workers and organisation, if used honestly.

UNIT 4
Industrial Relations
Basically, IR sprouts out of employment relation. Hence, it is broader
in meaning and wider in scope. IR is dynamic and developing socio-
economic process. As such, there are as many as definitions of IR as
the authors on the subject. Some important definitions of IR are
produced here.
Definition
According to Dale Yoder’, IR is a designation of a whole field of
relationship that exists because of the necessary collaboration of men
and women in the employment processes of Industry”.
Armstrong has defined IR as “IR is concerned with the systems and
procedures used by unions and employers to determine the reward for
effort and other conditions of employment, to protect the interests of
the employed and their employers and to regulate the ways in which
employers treat their employees”
Scope of IR:
1. Labour relations, i.e., relations between labour union and
management.
2. Employer-employee relations i.e. relations between management
and employees.
3. The role of various parties’ viz., employers, employees, and state in
maintaining industrial relations.
4. The mechanism of handling conflicts between employers and
employees, in case conflicts arise.
The main aspects of industrial relations can be identified as
follows:
1. Promotion and development of healthy labour — management
relations.
2. Maintenance of industrial peace and avoidance of industrial strife.
3. Development and growth of industrial democracy.
Objectives of IR:
1. Establish and foster sound relationship between workers and
management by safeguarding their interests.
2. Avoid industrial conflicts and strikes by developing mutuality
among the interests of concerned parties.

3. Keep, as far as possible, strikes, lockouts and gheraos at bay by
enhancing the economic status of workers.
4. Provide an opportunity to the workers to participate in management
and decision making process.
5. Raise productivity in the organisation to curb the employee
turnover and absenteeism.
6. Avoid unnecessary interference of the government, as far as
possible and practicable, in the matters of relationship between
workers and management.
7. Establish and nurse industrial democracy based on labour
partnership in the sharing of profits and of managerial decisions.
8. Socialise industrial activity by involving the government
participation as an employer.
Importance of industrial relation
1. Foster Industrial Peace:
Under the mechanism of IR, both employees and managers discuss
the matter and consult each other before initiating any actions.
Doubts, if any, in the minds of either party are removed. Thus,
unilateral actions that prop confusion and misunderstanding disappear
from the scene. In this way, IR helps create a peaceful environment in
the organisation. Peace, in turn, breeds prosperity.
2. Promote Industrial Democracy:
Industrial democracy means the government mandated worker
participation at various levels of the organisation with regard to
decisions that affect workers. It is mainly the joint consultations, that
pave the way for industrial democracy and cement relationship
between workers and management. This benefits the both. The
motivated workers give their best and maximum to the organisation,
on the one hand, and share their share of the fruits of organisational
progress jointly with management, on the other.
3. Benefit to Workers:
IR benefits workers in several ways. For example, it protects workers
against unethical practices on the part of management to exploit
workers by putting them under inhuman working conditions and
niggardly wages. It also provides a procedure to resolve workers’
grievances relating to work.

4. Benefit to Management:
IR protects the rights of managers too. As and when workers create
the problem of indiscipline, IR provides mangers with a system to
handle with employee indiscipline in the organisation.
5. Improve Productivity:
Experiences indicate that good industrial relations serve as the key for
increased productivity in industrial organisations. Eicher Tractors,
Alwar represents one such case. In this plant, productivity went up
from 32 per cent to 38 per cent between 1994 and 1997. This increase
is attributed to the peaceful IR in the plant.
WORKERS PARTICIPATION IN MANAGEMENT
Workers’ participation in management is an essential ingredient of
Industrial democracy. The concept of workers’ participation in
management is based on Human Relations approach to Management
which brought about a new set of values to labour and management.
Traditionally the concept of Workers’ Participation in Management
(WPM) refers to participation of non-managerial employees in the
decision-making process of the organization. Workers’ participation
is also known as ‘labour participation’ or ‘employee participation’ in
management. In Germany it is known as co-determination while in
Yugoslavia it is known as self-management. The International Labour
Organization has been encouraging member nations to promote the
scheme of Workers’ Participation in Management.
Workers’ participation in management implies mental and emotional
involvement of workers in the management of Enterprise. It is
considered as a mechanism where workers have a say in the decision-
The philosophy underlying workers’ participation stresses:
1. democratic participation in decision-making;
2. maximum employer-employee collaboration;
3. minimum state intervention;
4. realisation of a greater measure of social justice;
5. greater industrial efficiency; and
6. higher level of organisational health and effectiveness.
It has been varyingly understood and practised as a system of joint
consultation in industry; as a form of labour management cooperation;
as a recognition of the principle of co-partnership, and as an

instrument of industrial democracy. Consequently, participation has
assumed different forms, varying from mere voluntary sharing of
information by management with the workers to formal participation
by the latter in actual decision-making process of management
DEFINITION:-
ILO:
Workers’ participation, may broadly be taken to cover all terms of
association of workers and their representatives with the decision-
making process, ranging from exchange of information, consultations,
decisions and negotiations, to more institutionalized forms such as the
presence of workers’ member on management or supervisory boards
or even management by workers themselves.
The main implications of workers’ participation in management as
summarized by ILO:
 Workers have ideas which can be useful;
 Workers may work more intelligently if they are informed about
the reasons for and then intention of decisions that are taken in a
participative atmosphere
 According to Keith Davis, Participation refers to the mental and
emotional involvement of a person in a group situation which
encourages him to contribute to group goals and share the
responsibility of achievement.
 According to Walpole, Participation in Management gives the
worker a sense of importance, pride and accomplishment; it gives him
the freedom of opportunity for self-expression; a feeling of
belongingness with the place of work and a sense of workmanship
and creativity.
 Clegg says, “It implies a situation where workers
representatives are, to some extent, involved in the process of
management decision making, but where the ultimate power is in the
hands of the management”.
 According to Dr. Davis, “it is a mental and emotional
involvement of a person in a group situation which encourages him to
contribute to goals and share responsibilities in them”

Objectives:- :-
The objectives of workers’ participation in management are as
follows:
 To raise level of motivation of workers by closer involvement.
 To provide opportunity for expression and to provide a sense of
importance to workers.
 To develop ties of understanding leading to better effort and
harmony.
 To act on a device to counter-balance powers of managers.
 To act on a panacea for solving industrial relation problems.
CHARACTERISTICS
1.Participation implies practices which increase the scope for
employees’ share of influence in decision-making process with the
assumption of responsibility.
2. Participation presupposes willing acceptance of responsibility by
workers.
3. Workers participate in management not as individuals but as a
group through their representatives.
4. Worker’s participation in management differs from collective
bargaining in the sense that while the former is based on mutual trust,
information sharing and mutual problem solving; the latter is
essentially based on power play, pressure tactics, and negotiations.
5. The basic rationale tor worker’s participation in management is that
workers invest their Iabour and their fates to their place of work.
Thus, they contribute to the outcomes of organization. Hence, they
have a legitimate right to share in decision-making activities of
organisation.
Elements of Participation
The term “participation” has different meanings for different purposes
in different situations. McGregor is of the view that participation is
one of the most misunderstood idea that has emerged from the field of
human relations. Keith Davis has defined the term “participation” as
the mental and emotional involvement of a person in a group situation
which encourages him to contribute to group goals and share
responsibilities in them. This definition envisages three important
elements in participation. Firstly, it means mental and emotional

involvement rather than mere physical activity; secondly,
participation must motivate a person to contribute to a specific
situation to invest his own resources, such as initiative, knowledge,
creativity and ingenuity in the objectives of the organisation; and
thirdly, it encourages people to share responsibility for a decision or
activity. Sharing of responsibility commits people to ensure the
success of the decision or activity.
Forms of Participation
Different forms of participation are discussed below:
Collective Bargaining: Collective bargaining results in collective
agreements which lay down certain rules and conditions of service in
an establishment. Such agreements are normally binding on the
parties. Theoretically, collective bargaining is based on the principle
of balance of power, but, in actual practice, each party tries to outbid
the other and get maximum advantage by using, if necessary, threats
and counterthreats like; strikes, lockouts and other direct actions. Joint
consultation, on the other hand, is a particular technique which is
intended to achieve a greater degree of harmony and cooperation by
emphasising matters of common interest. Workers prefer to use the
instrument of collective bargaining rather than ask for a share in
management. Workers’ participation in the U.S.A has been ensured
almost exclusively by means of collective agreements and their
application and interpretation rather than by way of labour
representation in management.
Works Councils: These are exclusive bodies of employees, assigned
with different functions in the management of an enterprise. In West
Germany, the works councils have various decision-making functions.
In some countries, their role is limited only to receiving information
about the enterprise. In Yugoslavia, these councils have wider
decision-making powers in an enterprise like; appointment,
promotion, salary fixation and also major investment decisions.
Joint Management Councils and Committees: Mainly these bodies
are consultative and advisory, with decision-making being left to the
top management. This system of participation is prevalent in many
countries, including Britain and India. As they are consultative and

advisory, neither the managements nor the workers take them
seriously.
Board Representation: The role of a worker representative in the
board of directors is essentially one of negotiating the worker’s
interest with the other members of the board. At times, this may result
in tension and friction inside the board room. The effectiveness of
workers’ representative at the board depend upon his ability to
participate in decision-making, his knowledge of the company affairs,
his educational background, his level of understanding and also on the
number of worker representatives in the Board.
Workers Ownership of Enterprise: Social self-management in
Yugoslavia is an example of complete control of management by
workers through an elected board and workers council. Even in such a
system, there exist two distinct managerial and operative functions
with different sets of persons to perform them. Though workers have
the option to influence all the decisions taken at the top level, in
actual practice, the board and the top management team assume a
fairly independent role in taking major policy decisions for the
enterprises, especially in economic matters.
LEVELS OF MANAGEMENT
1Informative Participation:
This refers to management’s information sharing with workers on
such items those are concerned with workers. Balance Sheet,
production, economic conditions of the plant etc., are the examples of
such items. It is important to note that here workers have no right of
close scrutiny of the information provided and management has its
prerogative to make decisions on issues concerned with workers.
2.Consultative Participation:
In this type of participation, workers are consulted in those matters
which relate to them. Here, the role of workers is restricted to give
their views only. However the acceptance and non-acceptance of
these views depends on management. Nonetheless, it provides an
opportunity to the workers to express their views on matters involving
their interest.

3.Associative Participation:
Here, the role of the workers’ council is not just advisory unlike
consultative participation. In a way, this is an advanced and improved
form of consultative participation. Now, the management is under a
moral obligation to acknowledge, accept and implement the
unanimous decision of the council.
4.Administrative Participation:
In the administrative participation, decisions already taken are
implemented by the workers. Compared to the former three levels of
participation, the degree of sharing authority and responsibility by the
workers is definitely more in this participation.
5.Decisive Participation:
Here, the decisions are taken jointly by the management and the
workers of an organisation. In fact, this is the ultimate level of
workers’ participation in management.
Pre-requisites for Effective Participation
The pre-requisites for the success of any scheme of participative
management are the following:
1. Firstly, there should be a strong, democratic and representative
unionism for the success of participative management.
2. Secondly, there should be mutually-agreed and clearly-
formulated objectives for participation to succeed.
3. Thirdly, there should be a feeling of participation at all levels.
4. Fourthly, there should be effective consultation of the workers
by the management.
5. Fifthly, both the management and the workers must have full
faith in the soundness of the philosophy underlying the concept of
labour participation.
6. Sixthly, till the participative structure is fully accepted by the
parties, legislative support is necessary to ensure that rights of each
other are recognised and protected.
7. Seventhly, education and training make a significant
contribution to the purposeful working of participative management.
8. Lastly, forums of participation, areas of participation and
guidelines for implementation of decisions should be specific and
there should be prompt follow-up action and feedback.

Grievance Handling
Introduction and Definition of Grievance:
A grievance is any dissatisfaction or feeling of injustice having
connection with one’s employment situation which is brought to the
attention of management. Speaking broadly, a grievance is any
dissatisfaction that adversely affects organizational relations and
productivity. To understand what a grievance is, it is necessary to
distinguish between dissatisfaction, complaint, and grievance.
1. Dissatisfaction is anything that disturbs an employee, whether or
not the unrest is expressed in words.
2. Complaint is a spoken or written dissatisfaction brought to the
attention of the supervisor or the shop steward.
3. Grievance is a complaint that has been formally presented to a
management representative or to a union official.
According to Michael Jucious, ‘grievance is any discontent or
dissatisfaction whether expressed or not, whether valid or not, arising
out of anything connected with the company which an employee
thinks, believes or even feels to be unfair, unjust or inequitable’.
In short, grievance is a state of dissatisfaction, expressed or
unexpressed, written or unwritten, justified or unjustified, having
connection with employment situation.
Features of Grievance:
1. A grievance refers to any form of discontent or dissatisfaction with
any aspect of the organization.
2. The dissatisfaction must arise out of employment and not due to
personal or family problems.
3. The discontent can arise out of real or imaginary reasons. When
employees feel that injustice has been done to them, they have a
grievance. The reason for such a feeling may be valid or invalid,
legitimate or irrational, justifiable or ridiculous.
4. The discontent may be voiced or unvoiced, but it must find
expression in some form. However, discontent per se is not a
grievance. Initially, the employee may complain orally or in writing.
If this is not looked into promptly, the employee feels a sense of lack
of justice. Now, the discontent grows and takes the shape of a
grievance.

5. Broadly speaking, thus, a grievance is traceable to be perceived as
non-fulfillment of one’s expectations from the organization.
Causes of Grievances:
Grievances may occur due to a number of reasons:
1. Economic:
Employees may demand for individual wage adjustments. They may
feel that they are paid less when compared to others. For example,
late bonus, payments, adjustments to overtime pay, perceived
inequalities in treatment, claims for equal pay, and appeals against
performance- related pay awards.
2. Work environment:
It may be undesirable or unsatisfactory conditions of work. For
example, light, space, heat, or poor physical conditions of workplace,
defective tools and equipment, poor quality of material, unfair rules,
and lack of recognition.
3. Supervision:
It may be objections to the general methods of supervision related to
the attitudes of the supervisor towards the employee such as perceived
notions of bias, favouritism, nepotism, caste affiliations and regional
feelings.
4. Organizational change:
Any change in the organizational policies can result in grievances. For
example, the implementation of revised company policies or new
working practices.
5. Employee relations:
Employees are unable to adjust with their colleagues, suffer from
feelings of neglect and victimization and become an object of ridicule
and humiliation, or other inter- employee disputes.
6. Miscellaneous:
These may be issues relating to certain violations in respect of
promotions, safety methods, transfer, disciplinary rules, fines,
granting leaves, medical facilities, etc.
Effects of Grievance:
Grievances, if not identified and redressed, may adversely affect
workers, managers, and the organization.
The effects are the following:

1. On the production:
a. Low quality of production
b. Low productivity
c. Increase in the wastage of material, spoilage/leakage of machinery
d. Increase in the cost of production per unit
2. On the employees:
a. Increase in the rate of absenteeism and turnover
b. Reduction in the level of commitment, sincerity and punctuality
c. Increase in the incidence of accidents
d. Reduction in the level of employee morale.
3. On the managers:
a. Strained superior-subordinate relations.
b. Increase in the degree of supervision and control.
c. Increase in indiscipline cases
d. Increase in unrest and thereby machinery to maintain industrial
peace
Need for a Formal Procedure to Handle Grievances:
A grievance handling system serves as an outlet for employee
frustrations, discontents, and gripes like a pressure release value on a
steam boiler. Employees do not have to keep their frustrations bottled
up until eventually discontent causes explosion.
The existence of an effective grievance procedure reduces the need of
arbitrary action by supervisors because supervisors know that the
employees are able to protect such behavior and make protests to be
heard by higher management. The very fact that employees have a
right to be heard and are actually heard helps to improve morale. In
view of all these, every organization should have a clear-cut proce-
dure for grievance handling.
Objectives of Grievance Handling Procedure:
Objectives of the grievance handling procedure are as follows:
1. To enable the employee to air their grievance
2. To clarify the nature of the grievance
3. To investigate the reasons for dissatisfaction
4. To obtain, where possible, a speedy resolution to the problem
5. To take appropriate actions and ensure that promises are kept

6. To inform the employee of their right to take the grievance to the
next stage of the procedure, in the event of an unsuccessful resolution
Benefits of Grievance Handling Procedure:
Benefits that accrue to both the employer and employees are as
follows:
1. It encourages employees to raise concerns without fear of reprisal.
2. It provides a fair and speedy means of dealing with complaints.
3. It prevents minor disagreements developing into more serious
disputes.
4. It serves as an outlet for employee frustrations and discontents.
5. It saves employer’s time and money as solutions are found for
workplace problems. It helps to build an organizational climate based
on openness and trust.
Model for Grievance Resolution Procedure
1. The aggrieved employee shall convey his or her grievance verbally
to the officer designated by the management to deal with grievance.
The officer will have to reply to the complaints within forty-eight
hours of its presentation to him or her.
2. If the grievant is not satisfied with the answer or does not receive
the answer within 48 hours, he or she shall, then, present the
grievance to the departmental head nominated for this purpose. The
head must give his or her reply within three days of the presentation
of the grievance.
3. If the aggrieved employee is still not satisfied with the decision of
the departmental head or does not receive within the stipulated period,
the employee can approach to the Grievance Committee for the
settlement of his or her grievance. The Grievance Committee has to
give its recommendations in seven days and report the same to the
management. The management must communicate the decision to the
grievant within three days.
4. If still employee is not satisfied either with the decision made by
die Grievance Committee or does not receive decision from the
committee, he or she can make appeal to the management for revision
of the decision taken. The management can take a week period for
appeal to be considered and the revised decision to inform to the
grievant..

5. If the employee is still not satisfied with die management’s
decision, the grievance is referred to a voluntary arbitration within a
week after decision taken by the management at stage 4. The decision
of the arbitrator is final and binding on both the parties, i.e., the
management and the union.

COLLECTIVE BARGAINING
Meaning
The term collective bargaining is made up of two words, ‘collective’
– which means a ‘group action’ through representation and
‘bargaining’, means ‘negotiating’, which involves proposals and
counter-proposals, offers and counter-offers. Thus it means collective
negotiations between the employer and the employee, relating to their
work situations. The success of these negotiations depends upon
mutual understanding and give and take principles between the
employers and employees.
DEFINITION
Stevens: Collective Bargaining as a ‘social control technique for
reflecting and transmitting the basic power relationships which
underlie the conflict of interest in an industrial relations system.’
Prof. Allan Flanders: Collective Bargaining is primarily a political

rather than an economic process. He describes collective bargaining
as a power relationship between a trade union organization and the
management organization. The agreement arrived at is a compromise
settlement of power conflicts. Collective Bargaining has also been
described as “the great social invention that has institutionalized
industrial conflict” Dubin
Richardson says, “Collective bargaining takes place when a number

of work people enter into negotiation as a bargaining unit with an
employer or a group of employers with the object of reaching
agreement on conditions of the employment of the work people”.
The ILO has defined collective bargaining as "negotiations about
working conditions and terms of employment between an employer
and a group of employees or one or more employees' organizations
with a view to reaching an agreement wherein the terms serve as a
code of defining the rights and obligations of each party in their
employment relations with one another; fix a large number of detailed
conditions of employment, and derivatives validity, none of the
matters it deals which can in normal circumstances be given as a
ground for a dispute concerning an industrial worker"

OBJECTIVES:-
1. To foster and maintain cordial and harmonious relations between
the employer/management and the employees.
2. To protect the interests of both the employer and the employees.
3. To keep the outside, i.e., the government interventions at bay.
4. To promote industrial democracy.
Characteristics Of Collective Bargaining
1. It is a group process, wherein one group, representing the
employers, and the other, representing the employees, sit together to
negotiate terms of employment.
2. Negotiations form an important aspect of the process of
collective bargaining i.e., there is considerable scope for discussion,
compromise or mutual give and take in collective bargaining.
3. Collective bargaining is a formalized process by which
employers and independent trade unions negotiate terms and
conditions of employment and the ways in which certain
employment-related issues are to be regulated at national,
organizational and workplace levels.
4. Collective bargaining is a process in the sense that it consists of
a number of steps. It begins with the presentation of the charter of
demands and ends with reaching an agreement, which would serve as
the basic law governing labor management relations over a period of
time in an enterprise. Moreover, it is flexible process and not fixed or
static. Mutual trust and understanding serve as the by products of
harmonious relations between the two parties.
5. It a bipartite process. This means there are always two parties
involved in the process of collective bargaining. The negotiations
generally take place between the employees and the management. It is
a form of participation.
6. Collective bargaining is a complementary process i.e. each party
needs something that the other party has; labor can increase
productivity and management can pay better for their efforts.
7. Collective bargaining tends to improve the relations between
workers and the union on the one hand and the employer on the other.

8. Collective Bargaining is continuous process. It enables
industrial democracy to be effective. It uses cooperation and
consensus for settling disputes rather than conflict and confrontation.
9. Collective bargaining takes into account day to day changes,
policies, potentialities, capacities and interests.
10. It is a political activity frequently undertaken by professional
negotiators.
PROCESS OF COLLECTIVE BARGAINING:-
1. Prepare: This phase involves composition of a negotiation team.
The negotiation team should consist of representatives of both the
parties with adequate knowledge and skills for negotiation. In this
phase both the employer’s representatives and the union examine their
own situation in order to develop the issues that they believe will be
most important. The first thing to be done is to determine whether
there is actually any reason to negotiate at all. A correct
understanding of the main issues to be covered and intimate
knowledge of operations, working conditions, production norms and
other relevant conditions is required.
2. Discuss: Here, the parties decide the ground rules that will guide
the negotiations. A process well begun is half done and this is no less
true in case of collective bargaining. An environment of mutual trust
and understanding is also created so that the collective bargaining
agreement would be reached.
3. Propose: This phase involves the initial opening statements and the
possible options that exist to resolve them. In a word, this phase could
be described as ‘brainstorming’. The exchange of messages takes
place and opinion of both the parties is sought.
4. Bargain: negotiations are easy if a problem solving attitude is
adopted. This stage comprises the time when ‘what ifs’ and
‘supposals’ are set forth and the drafting of agreements take place.
5.Settlement: Once the parties are through with the bargaining
process, a consensual agreement is reached upon wherein both the
parties agree to a common decision regarding the problem or the
issue. This stage is described as consisting of effective joint
implementation of the agreement through shared visions, strategic
planning and negotiated change

Importance:
The need for and importance of collective bargaining is felt due to the
advantages it offers to an organisation.
The chief ones are as follows:
1. Collective bargaining develops better understanding between
the employer and the employees:
It provides a platform to the management and the employees to be at
par on negotiation table. As such, while the management gains a
better and deep insight into the problems and the aspirations of die
employees, on the one hand, die employees do also become better
informed about the organisational problems and limitations, on the
other. This, in turn, develops better understanding between the two
parties.
2. It promotes industrial democracy:
Both the employer and the employees who best know their problems,
participate in the negotiation process. Such participation breeds the
democratic process in the organisation.
3. It benefits the both-employer and employees:
The negotiation arrived at is acceptable to both parties—the employer
and the employees.
4. It is adjustable to the changing conditions:
A dynamic environment leads to changes in employment conditions.
This requires changes in organisational processes to match with the
changed conditions. Among other alternatives available, collective
bargaining is found as a better approach to bring changes more
amicably.
5. It facilitates the speedy implementation of decisions arrived at
collective negotiation:
The direct participation of both parties—the employer and the
employees—in collective decision making process provides an in-
built mechanism for speedy implementation of decisions arrived at
collective bargaining.
JOB SATISFACTION: The term job satisfaction, attitudes and
industrial morale are often used synonymously. An attitude may
contribute to job satisfaction. Similarly job satisfaction may also
contribute to morale. Thus, “job satisfaction is the result of various

attitudes the employee holds towards his job, towards allied factors
and towards life in general”. Job satisfaction is related to the feelings
and the emotional aspects of individuals experience towards his jobs.
Investigators have tried to correlate the different facts of workers
behaviour such as production, absenteeism accidents and turn over to
job satisfaction considering it a independent variable. Also many
investigators have considered job satisfaction as dependent variable
and tried to develop its relationship with personal variables such as
age, marital status, caste, education and number of dependents etc
Factors affecting job satisfaction
1.Working Conditions
Because employees spend so much time in their work environment
each week, it's important for companies to try to optimize working
conditions. Such things as providing spacious work areas rather than
cramped ones, adequate lighting and comfortable work stations
contribute to favorable work conditions. Providing productivity tools
such as upgraded information technology to help employees
accomplish tasks more efficiently contributes to job satisfaction as
well.
2. Opportunity for Advancement
Employees are more satisfied with their current job if they see a path
available to move up the ranks in the company and be given more
responsibility and along with it higher compensation. Many
companies encourage employees to acquire more advanced skills that
will lead to the chance of promotion. Companies often pay the cost of
tuition for employees taking university courses, for example. During
an employee's annual performance review, a supervisor should map
out a path showing her what she needs to accomplish and what new
skills she needs to develop in order to be on a track to advancement
within the organization.
3.Workload and Stress Level
Dealing with a workload that is far too heavy and deadlines that are
impossible to reach can cause job satisfaction to erode for even the
most dedicated employee. Falling short of deadlines results in conflict
between employees and supervisors and raises the stress level of the
workplace. Many times, this environment is caused by ineffective

management and poor planning. The office operates in a crisis mode
because supervisors don't allow enough time for employees to
perform their assigned tasks effectively or because staff levels are
inadequate.
4.Respect from Co-Workers
Employees seek to be treated with respect by those they work with. A
hostile work environment -- with rude or unpleasant coworkers -- is
one that usually has lower job satisfaction. In an August 2011 survey
published by FoxBusiness.com, 50 percent of those responding said
they had personally experienced a great amount of workplace
incivility. Fifty percent also believe morale is poor where they work.
Managers need to step in and mediate conflicts before they escalate
into more serious problems requiring disciplinary action. Employees
may need to be reminded what behaviors are considered inappropriate
when interacting with coworkers.
5.Relationship with Supervisors
Effective managers know their employees need recognition and praise
for their efforts and accomplishments. Employees also need to know
their supervisor's door is always open for them to discuss any
concerns they have that are affecting their ability to do their jobs
effectively and impeding their satisfaction at the office.
6.Financial Rewards
Job satisfaction is impacted by an employee's views about the fairness
of the company wage scale as well as the current compensation she
may be receiving. Companies need to have a mechanism in place to
evaluate employee performance and provide salary increases to top
performers. Opportunities to earn special incentives, such as bonuses,
extra paid time off or vacations, also bring excitement and higher job
satisfaction to the workplace.
7. Work Environment: The work environment has a great impact on
a person’s professional attitude and his approach towards his work.
People always enjoy working in a firm where colleagues are
enthusiastic about their work and seniors appreciate the effort you put
in.
Politics in an organisation is the first thing that dampens the
enthusiasm of an efficient employee. Employees feel wounded when

a non-deserving candidate gets promoted due to bias and partiality.
Firms that offer a good work environment tend to profit as well as
prosper in the long run.
8.. Nature Of Work: The nature of work can define your willingness
to work. Most individuals have a liking for certain tasks and would
prefer to handle these tasks. Make sure you go for firms where you
get to apply your skills, abilities and knowledge to the fullest. Your
interest in a certain task or job directly spells your devotion and
dedication to the job.
9.Your Job Stability and Security: The stability of your job is a
vital ingredient in your job satisfaction. If your job is not secure, you
are bound to worry about your career. This worry in turn affects your
sincerity and your mind starts wavering. To stay devoted and loyal to
the firm, you need to feel that your job is secure.
10. Your Salary and Increment: The remuneration offered by the
firm should match your value in the job market. If you feel that you
are underpaid, it will disappoint you. This stress and disappointment
will prevent you from putting in your best efforts.
HUMAN RESOURCE (HR) AUDIT
Human resources are the people in an organization, so a human
resources audit is a look at those people and the processes that put
them in place to make sure the system is working efficiently. An HR
audit also goes beyond looking at the hiring process into areas like
employee retention, budgeting, training, employee compensation,
management/employee relations and virtually any process or practice
within the company that affects its people.
A periodic Human Resource audit can qualify its effectiveness within

an organization. Human Resource audits may accomplish a variety of
objectives, such as ensuring legal compliance; helping maintain or
improve a competitive advantage; establishing efficient
documentation and technology practices; and identifying strengths
and weaknesses in training, communications and other employment
practices.
Human Resource auditing is something that many companies do

annually, just as they audit their financial information. This gives
them an accounting of their workforce and the efficiency with which
the organization as an entity deals with its people, from recruiting to
firing. Human Resource auditing can be likened to a person going to
the doctor for a general check-up to stay well. The process allows a
company to get a general idea of where it stands so it can better
correct any potential problems and plan for the future.
When it comes to physical health, prevention of problems is far better
than waiting until a problem arises and trying to cure it. The same
holds true for human resources auditing. Preventing problems is much
easier than trying to fix them after the fact. Good Human Resource
planning and auditing can help prevent those problems, and save
companies money and difficulties.
Human Resource Accounting benefits the company ascertain how
much Investment it has made on its Employees and how much return
it can expect from this Investment.
Definition:
Human Resource Audit means the systematic verification of job
analysis and design, recruitment and selection, orientation and
placement, training and development, performance appraisal and job
evaluation, employee and executive remuneration, motivation and
morale, participative management, communication, welfare and social
security, safety and health, industrial relations, trade unionism, and
disputes and their resolution. HR audit is very much useful to achieve
the organizational goal and also is a vital tool which helps to assess
the effectiveness of HR functions of an organization.
A complete Human Resources Checkup, including administration,
employee files, compliance, handbook, orientation, training,
performance management, and termination procedures. The intended
outcomes include minimizing your liability exposure and introduction
or enhancement of human resource best practices.
What is Human Resource Auditing?
The American Accounting Association’s Committee on Human
Resource Accounting (1973) has defined Human Resource
Accounting as “the process of identifying and measuring data about
human resources and communicating this information to interested

parties”.
HRA, thus, not only involves measurement of all the costs/
investments associated with the recruitment, placement, training and
develop ent of employees, but also the quantification of the economic
value of the people in an organisation.
Flamholtz (1971) too has offered a similar definition for HRA. They
define HRA as “the measurement and reporting of the cost and value
of people in organizational resources”.
Who should conduct the audit? The team that is responsible for the
audit should represent a cross-section of the organization’s staff,
including line staff, middle and upper management, and those
responsible for HR functions.
OBJECTIVES OF HR AUDIT
 To review the performance of the Human Resource Department
and its relative activities in order to assess the effectiveness on the
implementation of the various policies to realize the Organizational
goals.
 To identify the gaps, lapses, irregularities, short-comings, in the
implementation of the Policies, procedures, practices, directives, of
the Human Resource Department and to suggest remedial actions.
 To know the factors which are detrimental to the non-
implementation or wrong implementation of the planned Programmes
and activities.
 To suggest measures and corrective steps to rectify the mistakes,
shortcomings if any, for future guidance, and advise for effective
performance of the work of the Human Resource Department.
 v To evaluate the Personnel staff and employees with reference
to the Performance Appraisal Reports and suggest suitable
recommendations for improving the efficiency of the employees.
 To evaluate the job chart of the Human Resource Managers,
Executives, Administrative Officers, Executive Officers, Recruitment
Officers, whether they have implemented the directives and
guidelines for effective Management of the Human resources in their
respective Departments.
BENEFITS OF HR AUDIT

 Identifies the contribution of Human Resource department to the
organization
 Improves the professional image of the Human Resource
department.
 Encourages greater responsibility and professionalism among
member of the Human Resource department.
 Clarifies the HR department’s duties and responsibilities.
 Stimulates uniformity of HR policies and practices.
 Finds critical HR problems.
 Ensures timely compliance with legal requirements.
 Reduces human resource cost through more effective Human
Resource procedure.
 Creates increased acceptance of needed change in the Human
Resource department.
 Requires thorough review of Human Resourcedepartment’s
information system
COMPETENCY MAPPING
Competency approach to job depends on competency
mapping. Competency Mapping is a process to identify key
competencies for an organization and/or a job and incorporating those
competencies throughout the various processes (i.e. job evaluation,
training, recruitment) of the organization. A competency is defined as
a behavior (i.e. communication, leadership) rather than a skill or
ability.
DEFINITION:
According to Boyatzis(1982) “A capacity that exists in a person that
leads to behaviour that meets the job demands within parameters of
organizational environment, and that, in turn brings about desired
results”
The steps involved in competency mapping are presented below:
Conduct a job analysis by asking incumbents to complete a position
information questionnaire(PIQ). This can be provided for incumbents
to complete, or used as a basis for conducting one-on-one interviews
using the PIQ as a guide. The primary goal is to gather from
incumbents what they feel are the key behaviors necessary to perform
their respective jobs.

1. Using the results of the job analysis, a competency based job
description is developed. It is developed after carefully analyzing the
input from the represented group of incumbents and converting it to
standard competencies.
2. With a competency based job description, mapping the
competencies can be done. The competencies of the respective job
description become factors for assessment on the performance
evaluation. Using competencies will help to perform more objective
evaluations based on displayed or not displayed behaviors.
3. Taking the competency mapping one step further, one can use
the results of one’s evaluation to identify in what competencies
individuals need additional development or training. This will help in
focusing on training needs required to achieve the goals of the
position and company and help the employees develop toward the
ultimate success of the organization
ETHICAL ISSUES IN HRM
This article throws light on the seven major issues faced by human
resource, i.e, (1) Employment Issues, (2) Cash and Incentive Plans,
(3) Employees Discriminations, (4) Performance Appraisal, (5)
Privacy, (6) Safety and Health, and (7) Restructuring and layoffs.
1. Employment Issues:
HR professionals are likely to face maximum ethical dilemmas in the
areas of hiring of employees.
Major challenges in this area are:
a. Pressure to hire a friend or relative of a highly placed executive.
b. Faked credentials submitted by a job applicant.
c. Discovery that an employee who has been with the organisation for
some time, is skilled and has established a successful record, had lied
about his educational credentials.
2. Cash and Incentive Plans:
Cash and incentive plans include issues like basic salaries, annual
increments or incentives, executive perquisites and long term
incentive plans:
Basic Salaries:
HR managers have to justify a higher level of basic salaries or higher
level of percentage increase than the competitors to retain some

employees. In some situations, where the increase is larger than
normal they have to elevate some positions to higher grades. Annual
increment/incentive Plans. This situation is particularly true in case of
top management executives. The fear of losing some outstanding
executives, the HR managers is forced to give higher incentives to
them than what the individuals actually deserve.
Executive Perquisites:
In the name of executive perquisites, sometimes excesses are often
committed, the ethical burden of which falls on the HR managers.
Sometimes the costs of these perquisites are out of proportion to the
value added. For example, the CEO of a loss making company buys a
Mercedes for his personal use or wants a swimming pool built at his
residence.
Long term incentive Plans. Long term incentive plans are to be drawn
by the HR managers in consultation with the CEO and an external
consultant. Ethical issues arise when the HR manager is put to
pressure to favour top executive interests over the interests of the
other employees and the investors.
Employees Discriminations:
A framework of laws and regulations has been evolved to avoid the
practices of treatment of employees on the basis of their caste, sex,
religion, disability, age etc. No organisation can openly practice any
discriminatory policies, with regard to selection, training,
development, appraisal etc. A demanding ethical challenge arises
when there is pressure on the HR manager to protect the firm or an
individual at the expense of someone belonging to the group which is
being discriminated against.
Performance Appraisal:
Ethics should be the basis of performance evaluation. Highly ethical
performance appraisal demands that there should be an honest
assessment of the performance and steps should be taken to improve
the effectiveness of employees. However, HR managers, sometimes,
face the dilemma of assigning higher rates to employees who are not
deserving them; based on some unrelated factors eg. closeness to the
top management. Some employees are, however, given low rates,

despite their excellent performance on the basis of factor like caste,
religion or not being loyal to the appraiser.
Privacy:
The private life of an employee which is not affecting his professional
life should be free from intrusive and unwarranted actions.
HR managers face three dilemmas in this aspect:
(i) The first dilemma relates to information technology. A firm’s need
for information particularly about employees while on job may be at
odds with the employee’s privacy. Close circuit cameras, tapping the
phones, reading the computer files of employees etc. breach the
privacy of employees.
(ii) The second ethical dilemma relates to the AIDS testing. AIDS has
become a public health problem. HR managers are faced with two
issues: Whether all the new employees should be subject to AIDS test
and what treatment should be melted out to an employee who is
affected with the disease. It is however generally understood that
since AIDS cannot be contracted by casual and normal workplace
contract, employees with this illness should not be discriminated
against and they should be allowed to perform jobs for which they are
qualified.
(iii) The third ethical dilemma relates to Whistle Blowing. Whistle
blowing refers to a public disclosure by former or current employees
of any illegal, immoral or illegitimate practices involving their
employers. Generally, employees are not expected to speak against
their employers, because their first loyalty in towards the organisation
for which they work. However, if the situation is such that some act of
the organisation can cause considerable harm to the society, it may
become obligatory to blow the Whistle. The HR manager is in the
dilemma how to solve this issue between the opponents and defenders
of whistle blowing.
Safety and Health:
Industrial work is often hazardous to the safety and health of the
employees. Legislations have been created making it mandatory on
the organisations and managers to compensate the victims of
occupational hazards. Ethical dilemmas of HR managers arise when
the justice is denied to the victims by the organisation.

Restructuring and layoffs:
Restructuring of the organisations often result in layoffs and
retrenchments. This is not unethical, if it is conducted in an
atmosphere of fairness and equity and with the interests of the
affected employees in mind. If the restructuring company requires
closing of the plant, the process by which the plant is chosen, how the
news is to be communicated and the time frame for completing the
layoffs is ethically important.
HUMAN RESOURCE MANAGEMENT PRACTICES IN
INDIA.
1. Motivating the workforce
Due to the growth of the global market, a technological edge
supported by a talent pool has become a vital factor for survival in the
market. Due to the reason organization gives main priority to
technology advancement programs. HR managers are now performing
the role of motivators for their knowledge workers to adopt new
changes.
2. Managing people
Due to the increasing competition there is a need in the organization
for knowledge workers, hence the companies always look for
individual who can make a difference. Due to the reason gaining the
right knowledgeable person had become a costly deal for the
organizations but the attitude is different for those who are taking up
responsibilities at a lesser age and experience. These factors have
resulted in the clear shift in approach to individualized career
management from organization career commitment.
3. Competency Development
Human capital is the real asset for any organization, and this makes
the HR role important in recruiting, managing, and retaining the best.
The HR department has a clear role in this process and determines the
success tempo of any organization. An urgent priority for most of the
organizations is to have an innovative and competent HR pool; sound
in HR management practices with strong business knowledge.
4. Recruitment and training
Recruitment has become a major function from an imperative sub
system in HR. HR managers play a vital role in creating assets for the

organization in the form of quality manpower. Another challenge for
HR managers is to put systems in place to make the people a perfect
fit for the job. Talent redundancy has also become major issue due to
which HR departments provide related training programs. These
trainings are quite useful also in terms of providing security to the
employees.
5. Trust factor
Low levels of trust inhibit tacit knowledge sharing in the knowledge
based industry. It is essential that companies takes more initiatives to
improve the security levels of the employees.
6. Work life Balance Factor
This aspect creates with it the challenge of a smoother assimilation
and the cultural binding of the new comers into the organization fold.
The pressure of delivering the best of quality services in a reduced
time frame calls for ensuring that employees maintain a work life
balance.
7. Attrition/Retention of the Talent Pool
One of the toughest challenges for the HR managers in any industry is
to deal with the prevalent high attrition levels. Though there is an
adequate supply of qualified staff at entry level, there are huge gaps in
the middle and senior level management in the industry. Further, the
salary growth plan for each employee is not well defined. This
situation has resulted in increased levels of poaching and attrition
between organizations. The industry average attrition rate is 30-35 per
cent and could range up to 60 per cent.
8. Bridging the Demand Supply Gap
HR managers have to bridge the gap between the demand and supply
of professionals. They have to maintain consistency in performance
and have to keep the motivation levels of employees high, despite the
monotonous nature of work. The same also leads to recurring training
costs. Inconsistent performance directly affects revenues. Dwindling
motivation levels lead to a loss of interest in the job

MBA 2018
SUBJECT NAME:
PRODUCTION AND OPERATIONS
MANAGEMENT

MBA205-18 Production & Operations Management
Unit- I
Operations management: concept, functions, transformation process
model: inputs, process and outputs; classification of operations;
responsibilities of operations manager, contribution of Henryford,
Deming, Crossby, Taguchi.
Facility Location – importance, factors in location analysis, location
analysis techniques. Product Design and Development – product
design and its characteristics, product development process
(technical), product development techniques. Process selection-
project, job, batch, mass and process types of production systems.
operations management in corporate profitability and competitiveness
Unit- II
Facility Layout – Objectives, Advantages, Basic Types of Layouts,
Problems in facility layout. Production Planning & Control (PPC): –
Concepts, Objectives, and Functions, work study – Productivity:
Method study; Work measurement. Capacity Planning – Concepts,
Factors affecting Capacity Planning, Capacity Planning Decisions.
Unit- III
Quality Management: Introduction, Meaning, Quality Characteristics
of Goods and Services, Juran’s Quality Trilogy, Deming’s 14
principles, Tools and Techniques for Quality Improvement, Statistical
Process Control Chart, Quality Assurance, Total Quality Management
(TQM) Model Concept of Six Sigma and its Application. Acceptance
Sampling – Meaning, Objectives, Single Sample, Double Sample and
Multiple Sample Plans with sated risk, Control charts for variables –
Averages and Ranges, Control Charts for Defectives – Fraction
Defective and Numbers Defective.
Unit- IV
JIT and Lean Production System: JIT Approach, Implementation
requirements, Services, Kanban System. Inventory Management:
Concepts, Classification, Objectives, Factors affecting Inventory
Control Policy, Inventory Costs, Basic EOQ Model, Re-order level,
ABC analysis. Logistics and Franchising. Purchasing Management –
Objectives, Functions, Methods, Procedure.

Value Analysis: Concepts, Stock Control Systems, Virtual Factory
Concept and Production Worksheets.
Operations management is a technical term for a simple concept --
the way a company produces goods and services and delivers them to
customers. It focuses on carefully managing the processes to produce
and distribute products and services. Major, overall activities often
include product creation, development, production and distribution.
Production: Production is a scientific process which involves
transformation of raw material (input) into desired product or service
(output) by adding economic value. Production can broadly categorize
into following based on technique:
Production through separation: It involves desired output is
achieved through separation or extraction from raw materials. A
classic example of separation or extraction is Oil into various fuel
products.
Production by modification or improvement: It involves change in
chemical and mechanical parameters of the raw material without
altering physical attributes of the raw material. Annealing process
(heating at high temperatures and then cooling), is example of
production by modification or improvement.
Production by assembly: Car production and computer are example
of production by assembly.
Production and Operations Management concept
Successful organizations have well defined and efficient line function
and support function. Production comes under the category of line
function which directly affects customer experience and there by
future of organization itself. Aim of production function is to add
value to product or service which will create a strong and long lasting
customer relationship or association. And this can be achieved by
healthy and productive association between Marketing and Production
people. Marketing function people are frontline representative of the
company and provide insights to real product needs of customers. An
effective planning and control on production parameters to achieve or
create value for customers is called production management. As to
deliver value for customers in products and services, it is essential for
the company to do the following: Identify the customer needs and

convert that into a specific product or service (numbers of products
required for specific period of time)Based on product requirement do
back-ward working to identify raw material requirements Engage
internal and external vendors to create supply chain for raw material
and finished goods between vendor → production facility →
customers. Operations management captures above identified 3
points. Production management and operations management both are
very essential in meeting objective of an organization. Production
management is the process of effectively planning, organizing,
directing the controlling the production function or production system
i.e. the operations of that part of an enterprise which is responsible for
the actual transformation of materials into finished products. It deals
with man – machine organization to accomplish both productivity and
satisfaction – the desirable end results. Production/operations
management is the process, which combines and transforms various
resources used in the production/operations subsystem of the
organization into value added product/services in a controlled manner
as per the policies of the organization. Therefore, it is that part of an
organization, which is concerned with the transformation of a range of
inputs into the required (products/services) having the requisite
quality level. The set of interrelated management activities, which are
involved in manufacturing certain products, is called as production
management. If the same concept is extended to services
management, then the corresponding set of management activities is
called as operations management.
Functions of production and operations management
The functions of the production department depend on the size of the
firm. As such there may be no guidelines to specify the function of
production dept but the following are some of the functions which are
looked after by the production department
Materials: the selection of materials for the product, production
manager must have sound knowledge of materials and their properties
so that he can select appropriate materials for his product.
Methods: Finding the best method for the process, to search for the
methods that suit the available resources, identifying the sequence of
processes for manufacture of the product.

Machines and equipment: selection of suitable machinery for the
process desired, designing the maintenance policy and design of
layout of machines are taken care of by the production department.
Estimating: To fix the production targets and delivery dates and to
keep the production costs at minimum, production department does a
thorough of production times and costs.
Loading and scheduling; the production management department
has to draw a time table for various activities specifying when to start
and when to finish the process required.
Routing, this is concerned with fixing the flow lines for various raw
materials, components etc from stores to the packing of finished
products so that all the concerned know what exactly is happening on
the shop floor.
Dispatching; the activities of the shop floor follow given instructions
which are given by the production department.
Expediting or follow up; it is the responsibility of the production
department to know whether activities are being carried out as per
plans or not. Expediting helps to evaluate the plans
Inspection; this is generally done during production, but a separate
quality control department does quality inspection which is not
normally under production department.
Evaluation; the production department must evaluate itself and its
contribution in fulfilling the corporate objectives and departmental
objectives. This is necessary for setting future standards.
Transformation process model: inputs, process and outputs
Transformation processes
A transformation process is any activity or group of activities that
takes one or more inputs, transforms and adds value to them, and
provides outputs for customers or clients. Where the inputs are raw
materials, it is relatively easy to identify the transformation involved,
as when milk is transformed into cheese and butter. Where the inputs
are information or people, the nature of the transformation may be
less obvious. For example, a hospital transforms ill patients (the
input) into healthy patients (the output).
Transformation processes include:
 changes in the physical characteristics of materials or customers

 changes in the location of materials, information or customers
 changes in the ownership of materials or information
 storage or accommodation of materials, information or
customers
 changes in the purpose or form of information
 changes in the physiological or psychological state of
customers.
Often all three types of input – materials, information and customers –
are transformed by the same organisation. For example, withdrawing
money from a bank account involves information about the customer's
account, materials such as cheques and currency, and the customer.
Classification of operations
Processes fall into four different categories for operations
management based on the nature of their function. Some processes
relate primarily to a product’s cost structure; others address the
company’s product standardization needs, output volume, or
production flexibility. Take a look at processes that focus on these
types of business considerations and review general guidelines on
how to best select a process to meet the requirements of your product.
Before you dive into classifying a process, consider the nature of the
product it’s intended to produce. After all, creating a unique item,
such as an interstate highway bridge, is wildly different from
producing a million bottles of contact-lens solution or thousands of
socks in two different colors. Here are common process
classifications, arranged according to fixed costs (lowest to highest):
Projects: These generally result in an output of one. Examples
include constructing a building or catering a party. Although the result

of a project is one deliverable, the process of creating the item can be
duplicated with modifications for other projects.
Job shops: This type of process produces small batches of many
different products. Each batch is usually customized to a specific
customer order, and each product may require different steps and
processing times. Examples of job shop products include a bakery that
specializes in baking and decorating wedding cakes, each one
customized for a bride, or a programmer that creates customized
websites for his clients.
Batch shops: These produce periodic batches of the same product.
Batch shops can produce different products, but typically all the
products they produce follow the same process flow.
Flow lines: This type of process consists of essentially independent
stations that produce the same or very similar parts. Each part follows
the same process throughout the process. Output on a flow line is
dictated by the bottleneck, or the slowest operation. The flow line is
similar to the assembly line but the parts don’t move at a constant rate
dictated by the line speed. The terms flow lines and batch shop
process are often erroneously used interchangeably.
Assembly lines: These produce discrete parts flowing at controlled
rates through a well-defined process. The line moves the parts to the
resources, and each resource must complete its task before the line
moves on. This requires a balanced line, meaning that each operation
completes its task in a similar amount of time. The line moves at the
speed of the slowest operation, or bottleneck.
Continuous flow processes: As the name implies, these processes
produce items continuously, usually in a highly automated process.
Examples include chemical plants, refineries, and electric generation
facilities. A continuous flow process may have to run 24/7 because
starting and stopping it is often difficult. Responsibilities of
operations manager
An operations manager has a broad role, and the specific
responsibilities will vary between different companies, but generally
it includes monitoring and analysing the current system of production
or provision to check it’s effective, and working out a strategy for
improving if necessary.

By managing day-to-day activities, analysing statistics and reading
and writing reports, operations managers play a vital role in any
company.
Operations managers also have to do a lot of liaising with other team
members, including interacting with managers of different areas of
the organization, presenting findings to stakeholders and higher
management as well as training and supervising new employees and
tracking and measuring staff performance.
Other duties and responsibilities include:
 Planning and controlling change.
 Managing quality assurance programmes.
 Researching new technologies and alternative methods of
efficiency.
 Setting and reviewing budgets and managing cost.
Contribution of Henryford, Deming, Crossby, Taguchi.
Henry Ford was a revered American business magnate whose name is
easily identified with early 20th century American industrialism. He
founded Ford Motor Corporation in 1903 and was instrumental in
popularising the consumption of automotive vehicles in the United
States and positioning his country as a significant player in the global
automobile industry.It was in 1913 when Ford introduced a novel
manufacturing process called the moving assembly line. This process
allowed faster and inexpensive production of vehicles. The assembly
line also revolutionised manufacturing outside the automobile
industry with the introduction of Fordism—a concept and practice
that revolves around mass production of inexpensive goods and high
wages for workers.

THE MOVING ASSEMBLY LINE: THE CONTRIBUTION OF
HENRY FORD IN MANUFACTURING: The moving assembly
line is a key contribution of Henry Ford in manufacturing. Note that
this manufacturing process involves assembling several parts in a
step-by-step fashion. Each part moves from workstation to
workstation and with every movement, several parts were assembled
together until they become whole. In other words, parts are added or
assembled in sequence until a final assembly is produced.
Philip Crosby: The Four Absolutes of Quality Management:
 Quality is conformance to requirements
 Quality prevention is preferable to quality inspection
 Zero defects is the quality performance standard
 Quality is measured in monetary terms – the price of non-
conformance
14 Steps to Quality Improvement:
1. Management is committed to quality – and this is clear to all
2. Create quality improvement teams – with (senior)
representatives from all departments.
3. Measure processes to determine current and potential quality
issues.
4. Calculate the cost of (poor) quality
5. Raise quality awareness of all employees
6. Take action to correct quality issues
7. Monitor progress of quality improvement – establish a zero
defects committee.
8. Train employees in quality improvement
9. Hold “zero defects” days
10. Encourage employees to create their own quality improvement
goals
11. Encourage employee communication with management about
obstacles to quality
12. Recognize participants’ effort
13. Create quality councils
14. Do it all over again – quality improvement does not end

Dr. Edwards Deming
Deming’s Fourteen Obligations of Top Management
1. Create constancy of purpose for improvement of product and
service. Allocate resources to provide for long range needs rather than
only short term profitability
2. Adopt the new philosophy. We can no longer live with
commonly accepted levels of delays, mistakes, defective materials,
and defective workmanship.
3. Cease dependency on mass inspection to achieve quality.
Quality is achieved by building quality into the product in the first
place.
4. End the practice of awarding business on the basis of price tag
alone. The aim is to minimize total cost, not merely initial cost.
Establish long term relationship with suppliers to develop loyalty and
trust.
5. Improve constantly and forever every process for planning,
production, and service. It is management’s job to work continually
on improving total system.
6. Institute training on the job for all, including management, to
make better use of every employee. New skills are required to keep up
with changes in products and processes.
7. Adopt and institute leadership aimed at helping people do a
better job. Management must ensure that immediate action taken on
issues that are detrimental to quality.
8. Drive out fear so that everybody may work effectively and more
productively for the company.
9. Break down barriers between departments and staff areas.
Everyone must work together to tackle problems that may be
encountered with products or service.
10. Eliminate slogans and exhortations for the work force as they
create adversarial relationships. Also, bulk of the causes of low
quality & productivity belong to the system and lie beyond the power
of the work force.
11. Eliminate arbitrary numerical targets for the workforce and
management. Substitute aids and helpful leadership in order to
achieve continual improvement.

12. Remove barriers that rob people of pride of workmanship. This
includes the annual appraisal of performance and Management by
Objective.
13. Encourage education. Institute a vigorous program of education
and self-improvement for everyone
14. Clearly define top management’s permanent commitment to
ever improving quality and productivity. Put everybody in the
company to work to accomplish the transformation. Support is not
enough, action is required.
Dr. Genichi Taguchi
 The lack of quality should be measured as function of deviation
from the nominal value of the quality characteristic. Thus, quality is
best achieved by minimizing the deviation from target (minimizing
variation).
 Quality should be designed into the product and not inspected
into it. The product should be so designed that it is immune to causes
of variation.
Taguchi recommends a three-stage design process:
System Design (Stage 1):
 development of a basic functional prototype design
 determination of materials, parts and assembly system
 determination of the manufacturing process involved
Parameter Design (Stage 2):
 selecting the nominals of the system by running statistically
planned experiments (DFSS/DOE)
Tolerance Design (Stage 3):
deals with tightening tolerances and upgrading materials.
FACILITY LOCATION
Facility Location is the right location for the manufacturing facility, it
will have sufficient access to the customers, workers, transportation,
etc. For commercial success, and competitive advantage following are
the critical factors:Overall objective of an organization is to satisfy
and delight customers with its product and services. Therefore, for an
organization it becomes important to have strategy formulated around
its manufacturing unit. A manufacturing unit is the place where all
inputs such as raw material, equipment, skilled labors, etc. come

together and manufacture products for customers. One of the most
critical factors determining the success of the manufacturing unit is
the location.
Facility location determination is a business critical strategic decision.
There are several factors, which determine the location of facility
among them competition, cost and corresponding associated effects.
Facility location is a scientific process utilizing various techniques.
Location Selection Factors
For a company which operates in a global environment; cost,
available infrastructure, labor skill, government policies and
environment are very important factors. A right location provides
adequate access to customers, skilled labors, transportation, etc. A
right location ensures success of the organization in current global
competitive environment.
Industrialization
A geographic area becomes a focal point for various facility locations
based on many factors, parameters and issues. These factors are can
be divided into primary factors and secondary factors. A primary
factor which leads to industrialization of a particular area for
particular manufacturing of products is material, labor and presence
of similar manufacturing facilities. Secondary factors are available of
credit finance, communication infrastructure and insurance.
Errors in Location Selection
Facility location is critical for business continuity and success of the
organization. So it is important to avoid mistakes while making
selection for a location. Errors in selection can be divided into two
broad categories behavioral and non-behavioral. Behavioral errors are
decision made by executives of the company where personal factors
are considered before success of location, for example, movement of
personal establishment from hometown to new location facility. Non-
behavioral errors include lack of proper investigative practice and
analysis, ignoring critical factors and characteristics of the industry.
Location Strategy
The goal of an organization is customer delight for that it needs
access to the customers at minimum possible cost. This is achieved by
developing location strategy. Location strategy helps the company in

determining product offering, market, demand forecast in different
markets, best location to access customers and best manufacturing
and service location.
Factors Influencing Facility Location
If the organization can configure the right location for the
manufacturing facility, it will have sufficient access to the customers,
workers, transportation, etc. For commercial success, and competitive
advantage following are the critical factors:
Customer Proximity: Facility locations are selected closer to the
customer as to reduce transportation cost and decrease time in
reaching the customer.
Business Area: Presence of other similar manufacturing units around
makes business area conducive for facility establishment.
Availability of Skill Labor: Education, experience and skill of
available labor are another important, which determines facility
location.
Free Trade Zone/Agreement: Free-trade zones promote the
establishment of manufacturing facility by providing incentives in
custom duties and levies. On another hand free trade agreement is
among countries providing an incentive to establish business, in
particular, country.
Suppliers: Continuous and quality supply of the raw materials is
another critical factor in determining the location of manufacturing
facility.
Environmental Policy: In current globalized world pollution, control
is very important, therefore understanding of environmental policy for
the facility location is another critical factor.
Location analysis techniques.
Location Factor rating: The decision where to locate is based on many
different types of information and inputs. There is no single model or
technique that will select the "best" site from a group. However,
techniques are available that help to organize site information and that
can be used as a starting point for comparing different locations. In
the location factor rating system, factors that are important in the
location decision are identified. Each factor is weighted from 0 to
1.00 to prioritize the factor and reflect its importance. A subjective

score is assigned (usually between 0 and 100) to each factor based on
its attractiveness compared with other locations, and the weighted
scores are summed. Decisions typically will not be made based solely
on these ratings, but they provide a good way to organize and rank
factors.
Centre of Gravity Technique :In general, transportation costs are a
function of distance, weight, and time. The center-of-
gravity, or weight center, technique is a quantitative method for
locating a facility such as a warehouse at the center of movement in a
geographic area based on weight and distance. This method identifies
a set of coordinates designating a central location on a map relative to
all other locations.The coordinates for the location of the new facility
are computed using the following formulas:
where
x, y= coordinates of the new facility at center of gravity
xi, yi= coordinates of existing facility i
Wi= annual weight shipped from facility i
Load Distance Technique: A variation of the center-of-gravity method
for determining the coordinates of a facility location is the load-
distance technique. In this method, a single set of location coordinates
is not identified. Instead, various locations are evaluated using a load-
distance value that is a measure of weight and distance. For a single
potential location, a load-distance value is computed as follows:
where
LD = the load-distance value
li = the load expressed as a weight, number of trips, or units being
shipped from the proposed site to location i
di = the distance between the proposed site and location i
Product design and development: The term designing the product
refers to the determination of shape, standard and pattern of the
product. It includes Specification, Experimental and development
work for the production of desired product, Calculation of estimates
and drafting estimates of contracts for new inquiries, and Issuing
necessary instructions to the production department for production.
Generally, a separate technical department is established in big
industries that is assigned the responsibility of designing the product.
The technical department must clearly specify what is to be produced
by the production department not only because it has been entrusted
with the task of designing the product, but also for gaining and
retaining the goodwill of other manufacturers and consumers who will
use the product.
It is advisable that the cooperation of other concerning departments
should be sought in designing the product. Production and sales
departments are two main departments concerned. Thus, designing of
a product must be integrated with production and sales functions.
Characteristics of a Good Product Design
A good product design should posses the following characteristics:
1. Function :A product can be sold if it meets the needs of the
consumer and as such the product must be designed to meet such
needs. For example, a customer expects a gas lighter to be convenient
(i.e., to instantly light the gas stove). If the gas lighter cannot achieve
that, then the purpose is lost as the basic function is not met.
2. Reliability: It is the probability that there will not be any major
failure of the product during its use. For example, if certain
components of a product are put into use very often, the reliability of
each component should be staggeringly high which may not be
practical from production point of view. To overcome this problem,
duplicate components can be operated in parallel i.e., if one
component fails its duplicate may be put into operation.
3. Maintainability: The lubrication points and other areas for
servicing of the product to be designed, ought to be easily accessible
even though the physical form may have to be altered a bit. The
alternative is to make a trouble free product with expensive design.
The trade off between being trouble-free and maintainability is an
important decision at the design stage and it mainly depends on the
nature of the product. The after sales feedback from customers is
quite valuable in improving upon the maintainability of a product.

4. Producibility: A product should be designed in such a manner that
it can be produced easily at a reasonable cost. Least number of
operations are required to produce a product quickly and cheaply.
This may be possible with change in technology. For example, instead
of machining an intricate part such as gear, it can be molded, without
affecting its function.
Producibility can also be enhanced by reducing work content of the
job involved. For example, the instrument panel of a car used to be
maize of wires. This has been redesigned with a printed circuit board
where only multiple pin plug needs to be connected into it. This has
resulted into reduced work content and greater product reliability.
5. Simplification :Simplification and producibility go hand in
hand. The simpler the design of the product, the easier it is to
produce, the lesser it costs and more reliable it is.
6. Product standardization and variety reduction: Variety to a large
extent depends on market forces. The larger the market, the greater is
the degree of standardization possible which makes economies of
scale possible. If there is a competitive market, products can have a
selling edge if variety is offered. This will involve a design for the
product in such a way which will lend itself to modularisation so as to
gain advantage of large production.
7. Quality: A good quality product design ensures that the quality of a
final product is obtained through its individual components. The
tolerance specified at every stage ensures a end product with the
desired quality.
8. Minimum cost: Design influences manufacturing cost. A good
product design must ensure minimum manufacturing cost. Some of
the areas in which savings can be effected at the design stage have
been discussed already.
9. Warranties: Whether or not a manufacturer is legally bound to put
right whatever wrong the customer does is the question here. The
point is, a customer is too valuable to be lost, especially if the
manufacturer wishes to retain him and established his goodwill.
Breakdown of a component may or may not owe their origin to poor
maintenance or misuse of the component by a customer — it may be
due to faulty material, faulty design and faulty processing. The

manufacturer must keep in mind the importance of a customer and the
costs to be incurred in fixing up a product for the customer.
10. Modular design:The products should consist of detachable
components or sub-assemblies so that whenever a component fails, it
can be replaced by a new one easily. The use of standard sub-
assembly gives rise to numerous end products in different
combinations. The concept is known as modularity.The need of a
modular design is enforced by the customer who wants a variety to
choose from what he/she likes the best.
Product Development Process:Nowadays, companies are following
stage process for product development.
1. The 1st stage is idea generation that is the search for new
products. Companies pay a particular focus on customer needs and
demands to decide on the new product. Idea generation can also be
done by studying competitor’s product. Companies try to learn why
competitor’s product ticks with consumer or what more customers
want from that product. Companies also look at top management for
idea generation. For example, Steve Jobs of Apple is known to
participate actively in an idea generation. Research groups comprising
of scientist, patent holders, colleges and universities also serve as the
base for idea generation.
2. The 2nd stage is idea screening. Not all new ideas proposed can
be converted into products. Companies list ideas into three categories
promising ideas, marginal ideas and rejects. Promising ideas are
further process by screening committee to be ready for the next stage.
Screening should avoid the error where good ideas are dropped due to
bias towards the idea generator. Another commonly occurring error is
encouragement to a commercially unviable idea. Therefore, extra
precautions are necessary during the screening process.
3. The 3rd stage begins when ideas move into the development
process. Here a product idea is converted into several product
concepts. Out of several product concepts, the one which looks fit is
then placed against competitors to finalize marketing and positioning
strategy. Product concept is introduced to a focus group of customer
in a form of proto-type to understand their reaction.

4. The 4th stage involves developing of marketing strategy for
new product. The marketing strategy involves evaluation of market
size, product demand, growth potential, profit estimate in first few
years. Further marketing strategy plan is developed with the launch of
product, selection of distribution channel and budgetary requirements
for the 1st year.
5. The 5th stage involves the development of the business model
around the new product. Business models start with estimation of
sales, frequency of purchase, and nature of business. Next estimation
of cost and expense involve in production and distribution of new
product. In that basis profit estimations are reached. Discounted cash
flow and other methods are used to understand feasibility of new
product.
6. The 6th stage involves the actual production of new product.
Here more than one possible product are created, from proto-type to
finalized products are produced. Decisions are taken from operation
point of view whether is technically and commercially feasible to
continue production. If analysis is showing cost not within the
estimate then project is abandoned.
7. The 7th stage involves market testing of new product. The
new product is ready with brand name, packaging, price to capture
space in consumer’s mind.
8. The 8th stage involves launching of product across target market
backed by a proper marketing and strategy plan. This stage is
called commercialization phase.
Introduction of new product is part of survival technique for any firm.
And with very high failure rate companies have to follow a scientific
process to create new market offerings.Process Selection: Processes
fall into four different categories for operations management based on
the nature of their function. Some processes relate primarily to a
product’s cost structure; others address the company’s product
standardization needs, output volume, or production flexibility. Take
a look at processes that focus on these types of business
considerations and review general guidelines on how to best select a
process to meet the requirements of your product.Before you dive into
classifying a process, consider the nature of the product it’s intended

to produce. After all, creating a unique item, such as an interstate
highway bridge, is wildly different from producing a million bottles
of contact-lens solution or thousands of socks in two different colors.
Here are common process classifications, arranged according to fixed
costs (lowest to highest):
Projects: These generally result in an output of one. Examples
include constructing a building or catering a party. Although the result
of a project is one deliverable, the process of creating the item can be
duplicated with modifications for other projects.
Job shops: This type of process produces small batches of many
different products. Each batch is usually customized to a specific
customer order, and each product may require different steps and
processing times. Examples of job shop products include a bakery that
specializes in baking and decorating wedding cakes, each one
customized for a bride, or a programmer that creates customized
websites for his clients.
Batch shops: These produce periodic batches of the same product.
Batch shops can produce different products, but typically all the
products they produce follow the same process flow.
Flow lines: This type of process consists of essentially independent
stations that produce the same or very similar parts. Each part follows
the same process throughout the process. Output on a flow line is
dictated by the bottleneck, or the slowest operation. The flow line is
similar to the assembly line but the parts don’t move at a constant rate
dictated by the line speed. The terms flow lines and batch shop
process are often erroneously used interchangeably.
Assembly lines: These produce discrete parts flowing at controlled
rates through a well-defined process. The line moves the parts to the
resources, and each resource must complete its task before the line
moves on. This requires a balanced line, meaning that each operation
completes its task in a similar amount of time. The line moves at the
speed of the slowest operation, or bottleneck.
Continuous flow processes: As the name implies, these processes
produce items continuously, usually in a highly automated process.
Examples include chemical plants, refineries, and electric generation

facilities. A continuous flow process may have to run 24/7 because
starting and stopping it is often difficult.
Operations management in corporate profitability and
competitiveness :Operations management is important to an
organization’s managers for at least two reasons. First, it can improve
productivity, which improves an organization’s financial health.
Second, it can help organizations meet customers’ competitive
priorities.

Unit 2
FACILITY LAYOUT
For an organization to have an effective and efficient manufacturing
unit, it is important that special attention is given to facility layout.
Facility layout is an arrangement of different aspects of
manufacturing in an appropriate manner as to achieve desired
production results. Facility layout considers available space, final
product, safety of users and facility and convenience of operations.
An effective facility layout ensures that there is a smooth and steady
flow of production material, equipment and manpower at minimum
cost. Facility layout looks at physical allocation of space for economic
activity in the plant. Therefore, main objective of the facility layout
planning is to design effective workflow as to make equipment and
workers more productive.
Facility Layout Objective
A model facility layout should be able to provide an ideal relationship
between raw material, equipment, manpower and final product at
minimal cost under safe and comfortable environment. An efficient
and effective facility layout can cover following objectives:
1. To provide optimum space to organize equipment and facilitate
movement of goods and to create safe and comfortable work
environment.
2. To promote order in production towards a single objective.
3. To reduce movement of workers, raw material and equipment.
4. To promote safety of plant as well as its workers.
5. To facilitate extension or change in the layout to accommodate
new product line or technology upgradation.
6. To increase production capacity of the organization.
An organization can achieve the above-mentioned objective by
ensuring the following:
i.Better training of the workers and supervisors.
ii.Creating awareness about of health hazard and safety standards.
iii.Optimum utilization of workforce and equipment.
iv.Encouraging empowerment and reducing administrative and other
indirect work.

Factors affecting Facility Layout: Facility layout designing and
implementation is influenced by various factors. These factors vary
from industry to industry but influence facility layout. These factors
are as follows:
1. The design of the facility layout should consider overall
objectives set by the organization.
2. Optimum space needs to be allocated for process and
technology.
3. A proper safety measure as to avoid mishaps.
4. Overall management policies and future direction of the
organization
5. Design of Facility Layout
Principles which drive design of the facility layout need to take into
the consideration objective of facility layout, factors influencing
facility layout and constraints of facility layout. These principles are
as follows:
I.Flexibility: Facility layout should provide flexibility for expansion or
modification.
II.Space Utilization: Optimum space utilization reduces the time in
material and people movement and promotes safety.
III.Capital: Capital investment should be minimal when finalizing
different models of facility layout.
Design Layout Techniques: There are three techniques of design
layout, and they are as follows:
I.Two or Three Dimensional Templates: This technique utilizes
development of a scaled-down model based on approved drawings.
II.Sequence Analysis: This technique utilizes computer technology in
designing the facility layout by sequencing out all activities and then
arranging them in circular or in a straight line.
III.Line Balancing: This kind of technique is used for assembly line.
Types of FacilityLayout: There are six types of facility layout, and
they are as follows:
 Line Layout
 Functional Layout
 Fixed Position Layout
 Cellular Technology Layout
 Combined Layout, and
 Computerized Relative Allocation of Facility Technique
Problems in facility layout:Layout problems are found in several
types of manufacturing systems. Typically, layout problems are
related to the location of facilities (e.g., machines, departments) in a
plant. They are known to greatly impact the system performance
.These are as follows:
I.Some Pairs of department must be adjacent.
II.Some Pairs of department must not be adjacent
III.Some departments only in specific locations
IV.Existing building constraints etc.
Production Planning & Control (PPC):
Production planning and control is one of the most important phases
of production management, it is, as a matter of fact, the nervous
system of a manufacturing organization. In manufacturing
organization, it is essential that production is carried on in the best
manner at the lowest cost, and the goods are of right quality and are
produced at the proper time. This can be ensured only through proper
planning of production. but mere planning of production will not
solve the problem because production plans are not capable of self-
actuating and do not lead to automatic accomplishment. For that the
production manager has to take certain steps like, he has to regulate
work assignment, review the work progress, and devise methods to
bring conformity between the actual performance and planned
performance – so that plans chalked out are adhered to and the
standards set at the planning stage are properly attained and improved.
This is the function of ‘production control’. Production control,
therefore, is a directive function which involves the coordination and
integration of operations and activities of different factors of
production with a view to optimizing efficiency. Optimum efficiency
is attainable by proper planning of work, laying down of exact routes
which operations shall follow, correct fixing of time-table within
which productive operations shall start and come to a close,
uninterrupted releasing of orders and work facilities, and timely
initiation of appropriate follow-up steps to ensure smooth functioning

of the enterprise. In other words, production control involves
planning, routing, scheduling, dispatching and follow-up.
Definition:The concept of production planning and control can be
better understood with reference to a few definitions:
According to Spriegel and Lansburgh. “Production planning and
control is the process of planning production in advance of
operations: establishing the exact route of individual item, part, or
assembly; setting, starting, and finishing dates for each important
item, assembly, or the finished product; and releasing the necessary
order as well as initiating the required follow up to effectuate the
smooth function of the enterprise.”
In the words of Alford and Beatty, “Production planning and control
comprise the planning, routing, scheduling, dispatching and follow-up
functions in the productive process, so organized that the movements
of material, performance of machines, and operations of labor,
however subdivided, are directed and coordinated as to quantity,
quality, time and place.
Prof. Koepke production planning and control “as the coordination of
a series of functions according to a plan which will economically
utilize the plant facilities and regulate the orderly movement of goods
through their entire manufacturing cycle, form the procurement of all
materials to the shipping of goods at a predetermined rate”.
Objectives of Production Planning and Control
Basically production control function involves the coordination and
integration of the factors of production or production facilities to
produce a product at an optimum efficiency. An elaborate definition
of production control is given below:
“Production control is the function of directing and regulating the
orderly movement of goods through the entire production cycle form
the requisitioning of raw materials to the delivery of finished products
to meet the objectives of (i) customer service, (ii) minimum inventory
investment and (iii) maximum production efficiency”.
In this sense production control includes planning of production as
well as production control proper and also inventory control.
Production planning covers setting the requirements of production.

Production control covers keeping production within the planned
requirement.
Importance of Production Planning and Control
1. Plant’s Nervous Systems: Production planning and control
coordinates and regulates all plant operations just as our nervous
system regulates and coordinates the breathing and muscular
movement. In a large plant involving numerous parts and components
to manufacture a final product such as motor car, production planning
and control assumes importance.
2. Intermittent Process Industry: In intermittent process industry,
under batch production, goods are made as per order. in such
industries production planning and control become absolutely
necessary to assure deliveries as planned and as demanded by
customers.
3. Cost Control: Good production planning and control help optimize
the utilization of men, machinery, materials and money through
effective planning, organizing motivating and controlling multifarious
operations in the plant. The net result is reflected in reducing all costs
to the minimum.
4. Developing Economy: In a developing economy, production
planning and control is a boon for optimum use of scarce economic
resources particularly capital, machinery and equipment. Proper
planning and adequate control can accelerate industrial productivity
and consequently helps develop economy.
5. Rationalization of Plant Operations: Production planning and
control helps rationalization of plant operations and helps optimum
utilization of plant and machinery.
STEPS IN PRODUCTION PLANNING AND CONTROL
1. Planning
2. Routing
3. Scheduling
4. Dispatching
5. Expediting
Planning: The first important step in production planning and
control is concerned with the careful preparation of production plans.
Production plans determine what will be produced and where, at what

type, by whom, and how. For detailed planning of operations, the
relevant information may be obtained from several sources in the
enterprise. Information about quantity and quality of products to be
manufactured may be obtained from customers’ orders and the sales
budget, and information about production facilities may be obtained
from the management and the engineering department. Thus, the
planning function formulates production plans, and translates them
into requirements for men, machinery and materials.Whatever be the
planning period, production planning helps in avoiding randomness in
production, providing regular and steady flow of production activities,
utilizing production facilities to its maximum for minimizing
operating costs and meeting delivery schedules; coordinating various
departments of the enterprise for maintaining proper balance of
activities, and above all, providing the basis for control in the
enterprise.
Routing: The next important function of production planning and
control is routing which involves the determination of the path (i.e.
route) of movement of raw materials through various machines and
operations in the factory. “Routing”, to quote Spriegel and Lansburgh,
“includes the planning of where and by whom work shall be done, the
determination of the path that work shall follow, and the necessary
sequence of operations”. To find this path, emphasis is placed on
determining operating data, which usually includes planning of
‘where’ and ‘by whom’ work should be done, the determinations of
the path that work shall follow, and the necessary sequence of
operations. These operating data are contained in the standard process
sheet which helps in making out a routing in the standard process
sheet which helps in making out a routing chart showing the sequence
of operations and the machines to be used. If the machine loan chart
indicates the non-availability of certain machines, alternate routings
may also be included on the routing chart. The most efficient routing
may have to be compromised with the availability of the machines at
a particular time. In other words, “routing establishes the operations,
their path and sequence, and the proper class of machines and
personnel required for these operations.”

From the above, it can be inferred that routing is one of the highly
essential elements and prime considerations of production control
because many production control functions are closely related
processes and are dependent on routing functions. Thus, it is essential
to solve the different problems concerning: appropriate personnel; full
utilization of machines; and determining with precise degree the time
required in the production process.
Scheduling: Scheduling is planning the time element of production –
i.e. prior determination of “when work is to be done”. It consists of
the starting and completion times for the various operations to be
performed. In other words, scheduling function determines when an
operation is to be performed, or when work is to be completed, the
difference lies in the details of the scheduling procedure. To work out
effectively, the scheduling, as a part of production control function,
determines the time when each operation called for on the route sheet
is to be done on the specified machine in order to meet the desired
delivery dates. Good control function directs not only the time that
each particular operation should start but also indicates the progress
of each manufacturing part, the amount of work ahead of each
machine, and the availability of each machine for the assignment of
new work.Schedules are of two types: Master schedule and Detailed
schedule. Activities, if recorded on plant-wise basis, would be
preparing master schedule, while mere detailed schedules are
employed to plan the manufacturing and assembly operations required
for each product.
Dispatching: Dispatching is the part of production control that
translates the paper – work into actual production. It is the group that
coordinates and translates planning into actual production.
dispatching function proceeds in accordance with the details worked
out under routing and scheduling functions. As such, dispatching sees
to it that the material is moved to the correct work place, that tools are
ready at the correct place for the particular operations, that the work is
moving according to routing instructions. Dispatching carries out the
physical work as suggested by scheduling. Thus, dispatching implies
the issuance or work orders. These work orders represent authority to
produce. These orders contain the following information:

The name of the product;
The name of the part to be produced, sub-assembly or final assembly;
The order number;
The quantity to be produced;
Descriptions and numbers of the operations required and their
sequence,
The departments involved in each operation
The tools required for particular operation; and
Machines involved in each operation and starting dates for the
operations.
Expediting: Expedition or follow-up is the last stage in the process
of production control. This function is designed to keep track of the
work effort. The aim is to ensure that what is intended and planned is
being implemented. “Expediting consists in reporting production data
and investigating variances from predetermined time schedules. The
main idea behind expedition is to see that promise is backed up by
performance”. It includes the following functions:
(i) Check-up to ensure that all materials, tools, component parts,
and accessories are available at all work centers in specified quantities
for starting and carrying out manufacturing operations.
(ii) Check-up on the status of work-in-progress and completed work
at various work stations. This includes collecting information relating
to the starting and completion time and date of work completed, status
of work-in-progress relative to scheduled completion dates, position
of movements of materials, component parts, and sub-assemblies
within the plant, and inspection results.
(iii) Preparation of progress records and keeping the control boards
up-to-date.
(iv) Reporting to manufacturing management on all significant
deviations so that corrective action may be taken. It also includes
reporting to production planning department so that future plans may
be adjusted.
Thus production planning and control by completing the above

discussed phases ensures the manufacturing of goods of right quality,
quantity and at competitive market rates. One thing must be borne in

mind that production planning and control is a never-ending process,
and its various functions are inter-dependent.
REQUIREMENTS OF AN EFFICIENT SYSTEM OF
PRODUCTION PLANNING AND CONTROL
The scheme of production planning and control system will require
reliable information about productive capacities and production
standards, a sound organizational structure, and trained and competent
personnel, for it successful operations. These requirements are
enumerated below:
1. Reliable information about productive capacity and production
standards:
a) Complete knowledge of products be manufactured
b) Detailed information about the number and types of each
machine and processing unit together with the complete data on
power, speeds, and feeds of all machines.
c) Full information relating to production materials which are to be
used.
d) Accurate knowledge of job analysis – particulars as to the work
to be performed, and the type of skill required.
e) Information relating to completion times of all previous
operations and their actual cost.
f) Accurate knowledge of operation method, machine layout, and
the best way of handling a task.
g) Knowledge of the work-in-progress
h) Work performances expected from workers, machines etc.
i) Information regarding the orders on hand, their quality
specifications, and their delivery schedules.
2. Sound organizational structure:
a) A clear delineation of the authority – responsibility relationships
in the production planning and control department
b) Full and active support from the top management
3. Trained and competent personnel:
(a) Possession of requisite qualities to understand and perform
various operations.
(b) Well trained to assume newer and higher responsibilities.
(c) Scientifically remunerated.

ADVANTAGES OF PRODUCTION PLANNING AND
CONTROL
1. Efficient Service to Customers: The greatest advantage of a
proper system of production planning and control is that it renders
prompt and economical service to customers. This is possible by
proper scheduling and expediting of manufacturing operations which
enables a business enterprise to meet delivery dates. Not only that
customers are served on time, but they also get quality products.
2. Lower Investment: Proper production planning and control holds
investment to the minimum necessary level by avoiding unnecessary
stock inventories and machines.
3. Reduced Costs: Good production planning and control means
minimum waste of materials and labour efforts, avoidance of idle
machine time, and fewer production interruptions. All these reduce
production cost.
4. Higher Morale of Workers: Good production planning and
control system avoids rush orders, maintaining an even flow of work,
and providing congenial working conditions. All this means
avoidance of ‘speeding up’ of workers, maintenance of efficiency and
productivity and healthy attitude of workers towards work and work
organization. These elements determine the morale of the workers.
5. Better Public Relations: A well-planned and well-controlled
production system not only reduces investment and costs for the
enterprise, but also improves its image with the outside public. A
company that provides better quality products on announced time
schedule is looked favorably upon by the general public.
Thus, a good and efficient system of production planning and control
is beneficial to the manufacturer, workers, customers and the society.
“Work study is a generic term for those techniques, method study
and work measurement which are used in the examination of human
work in all its contexts. And which lead systematically to the
investigation of all the factors which affect the efficiency and
economy of the situation being reviewed, in order to effect
improvement.”
Framework of work study

Following are the advantages of work study:
1. It helps to achieve the smooth production flow with minimum
interruptions.
2. It helps to reduce the cost of the product by eliminating waste
and unnecessary operations.
3. Better worker-management relations.
4. Meets the delivery commitment.
5. Reduction in rejections and scrap and higher utilization of
resources of the organization.
6. Helps to achieve better working conditions.
7. Better workplace layout.
8. Improves upon the existing process or methods and helps in
standardization and simplification.
9. Helps to establish the standard time for an operation or job
which has got application in manpower planning, production
planning.
Method Study :
“A procedure for examining the various activities associated with the
problem which ensures a systematic, objective and critical evaluation
of the existing factors and in addition and imaginative approach while
developing improvements”.
There are three aspects of its application:
Method study proper is concerned with broad investigation and
improvement of a shop/section, the layout of equipment and machines
and the movement of men and materials.

Motion study is a more detailed investigation of the individual
worker/ operator, layout of his machines, tools, jigs and fixtures and
movement of his limbs when he performs his job. The ergomics
aspect i.e. study of environment, body postures, noise level and
surroundings temperature also form part of investigation.
Micro motion study i.e. much more detailed investigation of very
rapid movements of the various limbs of the worker.
So, motion study is an analysis of the flow and processing of material
and the movements of men through or at various work stations. Thus
motion study analyses the human activities which make up an
operation. Whereas method study or methods analysis has been
defined as: “systematic procedure for the critical analysis of
movements made by men, materials and machines in performing any
work”.
Now because by definition method study includes the study of all
facets of human work and all factors affecting the work so motion
study be considered as a part of method study.
Work measurement is the application of techniques which is
designed to establish the time for an average worker to carry out a
specified manufacturing task at a defined level of performance. It is
concerned with the duration of time it takes to complete a work task
assigned to a specific job.it means the time taken to complete one unit
of work or operation
Capacity planning is the process of determining the
production capacity needed by an organization to meet
changing demands for its products. In the context of capacity
planning, design capacity is the maximum amount of work that an
organization is capable of completing in a given period. Effective
capacity is the maximum amount of work that an organization is
capable of completing in a given period due to constraints such as
quality problems, delays, material handling, etc.
Factors Affecting Capacity Planning:
Capacity is affected by both external and internal factors.
The external factors include
(a) government regulations (working hours. safety, pollution),
(b) union agreements,

(c) supplier capabilities.
The internal factors include
(a) product and service design
(b) personnel and jobs (worker training, motivation, learning, job
content, and methods)
(c) plant layout and process flow
(d) equipment capabilities and maintenance
(e) materials management
(f) quality control systems
(g) product mix decisions
(h) management capabilities.Capacity Planning & Decisions
Capacity Planning Decisions:
Capacity of any facility is said to be the rate of productive capability
of it. Capacity otherwise can be assumed as the rate at which a facility
produces or in simple words, it is the ability of a facility to produce a
certain level of output within a specific time period. When a firm
decides to produce more of a product or plans to produce altogether a
new product, it always starts with deciding how much capacity is
needed considering the factors that affect capacity such as number of
workers and machines, skill set of workers, defects, suppliers,
government regulations ¦etc.
Need for Capacity Planning
A firm can determine its facility location and choose the process
technologies only after it has found out a need for new or expanded
facilities by evaluating the capacity or capacity planning. Lack of
capacity planning can result in under or over capacity and would incur
unnecessary costs in exploring ways to reduce or increase capacity.
Lack of capacity planning can also trigger a series of undesirable
events such as poor delivery services, an increase in work-in-process
and bring about dissatisfaction in the minds of the sales personnel and
the team involved in manufacturing. Decision making such as
producing new products, expanding production ¦etc can be difficult
without proper capacity planning.
Determinants of Capacity:The determinants of capacity are:
Facilities
Product and Service Factors

Process Factors
Manpower Factors
Operational Factors
Supply Chain Factors
External Factors
Importantanceof capacity decisions
Capacity decisions have its impacts on many different verticals of a
firm. Firstly it affects the ability to meet future demands, as without
capacity planning if not done keeping in mind the future demands
leads to a shortage of products. If capacity is underestimated or
overestimated it directly affects the operating costs as if capacity is
overestimated the operating costs involved would get wasted and if
underestimated the measures taken to fix it may cost a lot and so is
the way it affects the initial costs too.
How are Capacity Planning Decisions made?
Assessment of Existing Capacity.
Forecasting Future Capacity Needs.
Identification of Ways to Modify Capacity.
Evaluation of Financial, Economical, and Technological Capacity
Alternatives.
Selection of a Capacity Alternative most suited to achieving strategic
mission.

UNIT 3
Total Quality Management (TQM) is a systems approach to ensuring
quality in an organization. TQM is not just quality control or quality
assurance. Nor is it limited to the boundaries of a Total Quality
Control system. It is a dynamic process with a strong philosophical
base which incorporates many of the concepts upon which Total
Quality Control Systems are based. The emphasis is on involving
everyone in the organization in activities which provide for
continuous never-ending improvements. Quality activities are planned
and managed into the system and are oriented towards the
achievement of complete customer satisfaction. The liberalized
economy is forcing Indian companies to establish Total Quality
Management Systems. It is a struggle which has just begun and Indian
companies will continue to do so just to be in the race - lest they
perish. Quality will be just a qualifier, not a competitive advantage
anymore. TQM ettorts are led by top management by involving
everyone in the company with the prime objective of satisfying the
external customer. This focuses the organizational efforts towards
satisfying the internal customer with the help of a quality
management system for ' doing things right the first time. The
traditional approach of post-production detection of defects is
discouraged and a prevention philosophy is adopted to bring down the
non-conformances. The organization seeks continuous never-ending
improvements which are tracked with the help of appropriate
measurement systems. 22 Operations Management In this chapter the
focus will be on understanding the customer and the process and then
satisfying the customer by improving the process through total
involvement of employees. After a brief historical perspective on
TQM and its relevance to Indian organizations will define the various
terms relevant to quality management .TQM organizations focus on
understanding and responding to the needs of the customer. The voice
of the customer is clearly identified and then deployed throughout the
organization with minimum of distortions. The techniques used to
identify customer satisfaction and their expectations. We will
understand what Quality Function Deployment (QFD) means and
what is a house of quality.

Quality management systems have evolved through quality control
(QC), quality assurance (QA), and total quality control (TQC)
systems to total quality management (TQM) systems. We will briefly
sketch out each of these systems. Quality control is concerned with
defect detection by using post-production inspection procedures.
Statistical quality control techniques are used while inspecting the
finished goods. Main focus is on the product i. co what is wrong with
the product (or part). Techniques such as acceptance sampling,
control charts, control by attributes and control by variables are
typically used by the QC inspectors while controlling the quality of
goods manufactured. The extent of employee involvement is minimal.
Only few inspectors from the QC department are involved in quality
control activities. It takes a real short time (within days) to install a
QC system. However, such systems do not help identify problems.
Quality assurance systems aim to produce as per design specifications
and emphasize defect prevention. Quality is built into the system (that
produces the product) by using production and operations
management principles. Statistical process control techniques are used
to monitor the process by allowing random variations and eliminating
non random variations. Main focus is on the process -i.e., what is
wrong with the process which manufactures the product. Quality
system standards (such as ISO 9000) are adopted to assure quality in
the process. ISO 9000 is an International systems standard which
shows how an organization can establish, document and maintain an
effective quality system. It helps demonstrate to the customer that the
organization is committed to quality and has the ability to meet their
requirements. The employee involvement is limited within the
centralized-staff function of the QA department. It takes between six
to twelve months to install such a system. The main theme her is to
document (with well defined procedures) what you do and do what
you document.
Total quality control systems are concerned with cost reduction
efforts as a drive towards continual improvement. Here quality is
organized into the system. These systems take off once the cost of
quality is calculated. Problem areas are identified and problem
solving techniques are used extensively during the continuous

improvement cycle. Performance is monitored with the help of the
COQ system. These efforts enhance the product quality. Here waste
identification and removal is an important benefit. Philip Crosby's
zero defects program (Table 3.1) is a TQC approach. So is the
Taguchi methodology which emphasizes the importance of a robust
design to take care of all downstream fluctuations. In TQC systems
we have more involvement in the form of various quality circles
working towards improving the processes. Time to install is between
one to three years. It may be noted that QA standards form the basis
for a TQC or TQM approach.
Total quality management systems manage quality in. They have a
strong philosophical base that incorporates several important concepts
of TQC systems. Management efforts are oriented towards the
achievement of complete customer satisfaction. Here we find an
organization wide responsibility for quality. Time to install is three to
five years. The evolution shows a culture change in the organization
which achieves customer orientation through various stages of
development that progress through a systems oriented to an
improvement oriented to a prevention oriented state.how TQM
emerged over the century and who were the quality gurus who were
responsible for the status this philosophy commands today. The
progress from quality control to quality assurance to total quality
control to total quality management took almost a century of
concerted efforts from quality gurus, such as, Walter Shewhart, W.
Edwards Deming, Joseph Juran, Kaoru Ishikawa, Genichi Taguchi,
Armand Feigenbaum, and Philip Crosby. The quality movement was
initiated in Japan by Deming and Juran. It was later picked up by the
Japanese who have made the quality movement a big success story.
Around the 80s Japanese companies, on a continuous cycle of never-
ending improvements, surpassed the west. They captured the markets
with their consistent: quality products and have now shifted their
priorities on to satisfying customers with products having high quality
at low price.
Quality: There are several definitions of CK word. For example:
"Quality is customer satisfaction" "Quality means meeting customer
requirements" "Quality means fitness for use" "Quality is

conformance to specifications" "Totality of features and
characteristics of a product or service that bear on its ability to satisfy
stated or implied needs"
Customer: "Anyone who is impacted by the product or service". By
this definition we find that there are several customers waiting down
the line when a product is being processed through several stages in
an organization before it reaches the final consumer. Thus we have
people who are impacted within the organization and also people
impacted outside the organization. Thus we have two type of
customers - the internal customers and the external customers.
Product: Output of any process. Classified into goods, software and
services.
Quality and Customer Satisfaction: We achieve customer
satisfaction with the help of several product features. Or through
products that are free from deficiencies. Products having good
features meant to attract customers are said to have good quality of
design. The various dimensions of design quality could be
performance, reliability, durability, ease-of-use, serviceability,
aesthetics, availability of options (additionalfeatures and
expandability), and reputation. In a service setup the dimensions are
accuracy, timeliness, completeness, friendliness, anticipating
customer needs, knowledge of server, aesthetics and reputation.
Hence they have the capabilities of commanding high price and share
and therefore earning higher revenue. On the other hand products
having less deficiencies are said to have good quality of conformance.
Lower deficiencies are achieved through waste reduction leading to
lower costs thereby yielding higher profits. Freedom from
deficiencies or conformance to standards are necessary at delivery,
during use and during servicing. In addition, other supporting
business processes such as sales and billing should be free from
errors. Higher conformance means fewer complaints which implies
greater customer satisfaction. The net effect of improved quality of
design and conformance is increased profits.
Quality and Productivity: The focus of productivity is now shifting.
The old factory-oriented definition of productivity is " product (or
service) output per unit of resource input". The new market-oriented

concept is "salable, good quality product (or service) output per unit
of resource input." The higher the value the better is the productivity.
In TQM we try to identify the key processes on -which the success of
the organization depends. Key processes could be (a) processes that
produce the most important products wanted by customers, (b)
processes having high visibility with customers, or (c) processes
having well defined problem areas indicating a high potential for
improvement. Once the processes have been identified the ownership
has to be assigned to fix authority and responsibility for maintaining,
operating and improving the process. Quality improvement is
achieved through systematic and continuous improvement of these
key processes. To know whether a system is improving or not we
need to have a measurement framework to monitor the system
performance. Performance monitoring can be done by recording cost
of quality summaries. Quality costs include costs of assuring and
ensuring quality- together with the losses incurred through failures
within and outside the organization. Cost of quality can be broadly
classified into cost of conformance and cost of nonconformance. Cost
of conformance includes costs of prevention and appraisal while cost
of nonconformance includes costs of internal and external failures.
Appraisal costs are costs of inspection, testing, verification and
control at any stage in the process meant to ensure acceptance of the
product or process. Prevention costs involve costs of activities
undertaken to prevent or reduce the risk of nonconformity. Prevention
activities include identification of nonconformities, identification of
their causes and also actions taken to remove such causes. Thus
prevention costs are incurred in getting things done right the first
time. Internal failure costs are due to defects and nonconformities
that-are identified within the organization. They include costs due to
scrap, rework, repair, and re-test. External failure costs are due to
defects passing out of the organization. They include costs such as
warranty claims, loss of customer goodwill, replacement costs and so
on. Refer the recommended texts at the end of this chapter to get an
exhaustive list of these quality related costs. It has been estimated that
quality costs account for 20 to 30 percent of a company's revenue.
Cutting down the cost of quality is the goal of TQM organizations. In

organizations implementing TQM prevention costs rise in the initial
stages because of investments in systems, processes, planning and
training. Appraisal costs gradually reduce because post production
inspection activities are no longer necessary. As prevention measures
start taking effect the failure costs and the total quality costs start
decreasing. This is in contrast to the traditional quality measurements
processes where quality products were supposed to be delivered at
high costs, shows the difference between traditional quality and total
quality concepts. Thus having a cost of quality system in place can
help a company track improvements over time. We can also measure
and monitor a systems quality improvement program by identifying
non-conformances. A nonconformance is any deviation from
measurable quality specifications that need to be satisfied. Quality
improvement programs are most effective if we identify non-
conformances in terms of quantity and cost, and systematically strive
to eliminate dominant non-conformances. Nonconformance could be
in one of the following several forms: Defects (i.e., work not to
specification) Rework (i.e., work requiring correction) Scrap (i.e.,
work thrown away) Backlogs (i.e., work behind schedule) Late
deliveries (i.e., work after due date) ' Surplus items or over-production
(i.e., work not required) We need a well defined measurement system
to capture non-conformances in a database. Next we sort the data and
identify dominant non-conformances (in different sections of the
organization) to prioritize quality improvement actions appropriately.
We generate summaries of : a) nonconformance quantities and costs,
(b)scrap.
ISO 9000 is a series of standards agreed upon by the Geneva based
International Organization for Standardization (ISO), It was adopted
in 1987. It is a set of written standards laying down a quality system.
The basic elements of the system are defined through documentation.
The guidelines ensure universally recognized and uniform quality
systems that are rooted in the customer's requirements. ISO 9000
creates a discipline required for a TQM organization.
Here are some highlights:
ISO 9000 CERTIFICATION IS ISSUED BY INDEPENDENT
ISOCERTIFIED AUDITORS. REGISTRATION WILL BE

INCREASINGLY DRIVEN BY CUSTOMER REQUIREMENTS &
COMPETITIVE PRESSURES, NOT VIA OFFICIAL OR
STATUTORY MANDATE. CERTIFICATION ONLY VERIFIES
THAT YOUR FACTORY, YOUR LABORATORY, OR YOUR
OFFICE MEETS A SET OF PREDETERMINED (by ISO)
QUALITY MANAGEMENT REQUIREMENTS.
DOCUMENTATION IS CENTRAL TO ISO 9000
REQUIREMENTS,
FOR THE PURPOSES OF PLANNING, CONTROLLING,
TRAINING & PROVIDING OBJECTIVE EVIDENCE OF
COMPLIANCE.
ISO 9000 IS NOT A PRODUCT STANDARD BUT A QUALITY
SYSTEM STANDARD. IT IS DESIGNED & INTENDED TO
APPLY TO VIRTUALLY ANY PRODUCT OR
SERVICE MADE BY ANY PROCESS ANYWHERE IN THE
WORLD. ISO 9000 REQUIRES THAT THE QUALITY SYSTEM
MONITOR CONFORMANCE TO REQUIREMENTS.
ISO 9000 helps companies that market their products in the European
markets. It is essential for companies (or vendors) supplying to other
companies that demand ISO 9000 certification. It is also necessary for
companies whose competitors are certified or are seeking ISO 9000
certification. Companies with geographically scattered facilities &
global operations find it easier to convince customers about their
quality standards, if they have ISO 9000 certification. It is also meant
for companies whose transnational parents are seeking ISO 9000
certification. ISO 9000 originated from the U.S. Department of
Defense (quality) standards. The British Standards Institute adopted
these standards in 1979 for business processes and used them as its
national standard under the name of British Standard 5750. BS5750
was adopted by ISO in 1987 and called it ISO 9000 series. These
series have undergone revision in 1994. Here are some harmonized
versions of ISO 9000.

UNIT 4
Just-in-Time (JIT) is a Japanese innovation, and key features of this
were perfected by Toyota. Some facets of the management practices
Toyota developed are ideologically related to Japan's unique customs,
culture, and labour - management relations. However there is nothing
uniquely Japanese about JIT production and it is usable anywhere.
The concepts have been applied successfully in many companies
throughout the world. JIT production means producing and buying in
very small quantities just in time for use. It is simple hand to mouth
mode of industrial operations that directly cuts inventories and also
reduces the need for storage space, racks, conveyors, forklifts,
computer terminals for inventory control and of course material
control personnel. Products are assembled just before they are sold,
subassemblies are made just before the products are assembled, and
components are fabricated just before the subassemblies are made - so
work-in-process (WIP) inventory is low and production lead times are
short. To operate with these low inventories, the companies must be
excellent in other areas. They must have consistently high quality
throughout the organizations. To achieve this quality and
coordination, they must have the participation and cooperation of all
employees. So TIT manufacturing or manufacturing excellence is a
broad philosophy of continuous improvement. More important, the
absence of continuous improvement. More important, the absence of
extra inventories creates an imperative to run an error free operation
because there is no cushion of excess parts to keep production going
when problems crop up, causes of error are rooted out, never to occur
again. The JIT transformation begins with inventory removal. Fewer
materials are bought, and parts and products are made in smaller
numbers; that is the lot size inventories thereby decrease. This
immediately results in work stoppages. Production comes to standstill
because feeder processes breakdown or produce too many detectives
and d-there are no buffer stock to keep things going on. Once this
happens, analysts and engineers try to solve the problems and keep
things going on. Each round of problem exposure and solution
increases productivity and quality too. Just-in-time (JIT) is a
philosophy of improvement through aggressively discovering and

resolving any problems or weaknesses that impede the organization's
effectiveness and efficiency. Basically, it seeks to eliminate all waste
within the organisation, including the waste of underutilizing the
talents, skills, and potential of its employees. Anything that does not
contribute to add in value for an internal or external customer is
considered waste. The philosophy originated in manufacturing
operations, but its concepts have been applied in other area such as a
means of work, service and distribution. JIT can be very effective and
powerful as a means of improvement.
Just-in-time systems focus on reducing inefficiency and unproductive
time in the production process to improve continuously the process
and the quality of the produce or service. Employee involvement and
inventory reduction are essential to JIT operations. Just-in-time
systems are known by many different names, including zero inventory
synchronous manufacturing , lean production, stock less production
(Hewlett- Packard), material as needed (Harley - Davidson ), and
continuous flow manufacturing (IBM).
In this section the following characteristics of JIT systems : People
involvement, Team Work, Discipline, Total quality management, pull
method of material flow, small lot sizes, short setup times, uniform
workstation loads, standardized components and work methods, close
supplier ties, flexible work force, product focus, automated
production, and preventive maintenance.
People Involvement Probability all management efforts have some
behavioural aspects, because management is working through other
people to accomplish the organization's objectives. Management plans
and decisions only lay the groundwork. This is the resulting human
behaviourthat determines a company's success or failure. Such terms
as zero inventory and stock less production have given some people
the impression that JIT is only an inventory program. JIT has a strong
human resources management components that must be recognized if
the technical component is to be fully successful. Much of the success
of JIT can be traced to the fact that companies that use it train their
employees to have the appropriate skill, give them responsibility, and
coordinate and motivate them. The JIT philosophy of continuous
improvement and minimization of waste considers waste to be any

activity that does not add value to the product or serve the customer in
some way. One form of waste that is inconspicuous and difficult to
combat is the underutilization of human talent. JIT seeks to utilize
more fully the creative talents of employees, suppliers,
subcontractors, and others who may contribute to the company's
improvement. Businesses ultimately succeed or fail because of their
people. JIT is no exception to this rule. Because JIT is a system of
enforced problem solving, having a dedicated work force committed
to working together to solve production problem, is essential. JIT
manufacturing, therefore, has a strong element of training and
involvement of workers in all phases of manufacturing. 12.4.2
Teamwork First, and foremost, a culture of mutual trust and
teamwork must be developed in an organization. Managers and
workers must see each other as co-workers committed to the
company's success. Successful people involvement steams from a
culture of open trust and teamwork in which people interact to
recognize, define, and solve problems. Sometimes it is mistakenly
assumed that this component is just another program, such as a
suggestion program or a quality circle program. People involvement
can include these programs and others, such as adhoc project teams
that focus on specific improvement targets and semi-autonomous
work teams whose membership seldom changes. The involvement
components of JIT is much broader than a program or two: it is a
management style and a permanent company wide attitude of
teamwork. So that each person works to improve the company.
People are encouraged to suggest ways to improve methods which are
quickly and fairly considered, ignoumbasupport.blogspot.in Just-in-
Time and the companies are open to trying something new that seem
like a worthwhile improvement.
Another important factor that is crucial to JIT is the
empowerment of workers. This means that workers are given the
authority to take the initiative in solving production problems. Rather
than waiting for guidance from above, workers have the authority to
stop production at any time for such things as quality problems
machine malfunctions or safety concerns. Groups of workers are then
encouraged to work together to quickly get production going again.

Once workers have identified problems. They are encouraged to meet
during breaks before work or after work to discuss the problems.
Having workers actively involved in problem solving is the objective
of worker empowerment. People, suppliers, workers, managers and
customers must all be motivated and committed to teamwork for JIT
manufacturing to be effective.
Discipline This open, improvement - driven atmosphere does not
mean, however, that any employee is free to work by any method he
or she choose to try. Usually there is a standard way each job is to be
done. If an improvement is suggested and approved, a new standard
procedure will be adopted. This standardization prevents variations in
products or services which can cause defects. Defects occur- because
some variation has been introduced into a material or procedure that
normally products good result. When an efficient procedure that
results in good quality is established, it is to be followed until a better
way is tested and approved. You can see that creativity and openness
to change are needed, but it is creativity in conjunction with
teamwork and discipline that achieves consistent good quality and
leads to improvements.
Total Quality Management (TQM) JIT systems seek to eliminate
scrap and rework in order to achieve a uniform flow of materials.
Efficient JIT operations require conformance to product or service
specifications. JIT systems control quality at the source, with workers
acting as their own quality inspectors. JIT manufacturing depends on
a system of TQM being in place. Successful JIT manufacturing goes
hand-in-hand with an organization-wide TQM culture. Just as
everyone has to be involved in JIT, so also must everyone be involved
in TQM. Total commitment to producing products of perfect quality
every time and total commitment to producing products for fast
delivery to customers have one essential thing in common Both are
finely focused on the overall goal of satisfied customers.
Pull Method of Material Flow Just-in-time systems utilize the pull
method of material flow. However, another popular method of
material flow is the push method. To differentiate between these two
systems, we consider the production system for a fast food dish at a
restaurant. There are two workstations. The dish maker is the person

responsible for producing; this dish: the cutlets must be prepared;
buns must be toasted and then dressed with ketchup, pickles, onions,
lettuce, and cheese; and the cutlets must be inserted into buns and put
on a tray. The final assembler takes the tray, wraps the buns in paper,
and restocks the inventory. Inventories must be kept low because any
buns left unsold after ten minutes must be destroyed. The flow of
materials is from the dish maker to the final assembler to the
customer. One way to manage this flow is by using the push method,
in which the production of the item begins in advance of customer
needs. With this method, management schedules the receipt of all raw
materials (e.g., vegetables, buns, and condiments) and authorizes the
start of production, all in advance of the dish needs. The dish maker
starts of production no. of dish (the capacity of the griddle ) and,
when they are completed, pushes them along to the final assembler's
station, where they might have to wait until he is ready for them. The
packaged dishes then wait on a warming tray until a customer
purchases one. The other way to manage the flow among the dish
maker, the final assembler, and the customer is to use the pull method,
in which customer demand activates production of the item. With the
pull method, as customer purchase dish, the final assembler checks
the inventory level of dish and, when they are almost depleted, orders
six more. The dish maker produces the six dish and gives the tray to
the final assembler, who completes the assembly and places the dish
in the inventory for sale. The pull method is better.
THE KANBAN SYSTEM Accomplishing the Just-in-Time objective
rests on systems for determining production methods, and the
information system called Kanban. Both of these concepts contributed
to the objective of having the right number of parts or components at
the right place at the right time. The Kanban system is a unique
Japanese information system that "harmoniously" controls the
production quantities in each process. The Kanban system is a simple
information system used by a Work Centre (WC) to signal its supplier
WC to send a container of an item and to authorize the supplier WC
to make another container of the particular item. The name comes
from the Japanese word kanban, which means "card" or " sign" .
Originally a card was used to signal the supplying work center. A WC

can use any of a variety of methods to trigger resupply by its supplier
WC. For example, a flashing light, the empty container itself, or a
message on a computer terminal can communicate a request for more
material. We discuss the two-card kanban system to provide some
detail about how it is linking work centers. In the two-card kanban
system, one type of card, called a production card, or P-card,
authorize a WC to make one standard container of a particular part
specified on the card. The second type of card, called a move card, or
M-card, authorizes the movement of one, container of the specified
part from a particular WC to another WC as specified on the card.
These cards are ordinarily recirculated and new cards are issued only
when production of an item is to be started or changed significantly.
The prduction card circulates repeatedly between the outbound
material location at a WC and the work area where the item is
produced. Similar card transactions link the supplier WC and the WCs
that supply it. The user WC will also be linked to one or more WCs
that supplies. A series of these linkages connects the final assembly
operation with the WC that performs the first operations in making
the product. Often, even the raw material vendor is linked with the
starting operation through -a kanban signal. Kanbans picked up when
one delivery is made authorize the vendor to make specified items and
deliver them on the next delivery. 24 The kanban systems can be a
very simple, inexpensive, and effective method of coordinating work
centers and vendors. The organizations must be well disciplined so
that there is always an authorizing kanban with every container,
ensuring that only the appropriate items are produced and excessive
inventory does not build up. There is also the opposite danger-that
some WC might run out of material and cause work to stop at work to
stop at all subsequent WCs. If this or any other pull method is to work
well with small inventories, there must be no problems to disrupt
production: because there simply is not enough inventory to keep the
plant running while a problem is corrected.
Numeric example of Kanban system:Example : (Adapted from
Production and Operations Management by E.E.Adam and R.J.Ebert,
PHI. New Delhi) The process of making component xy943 for the
Digital Maestro CD player involves five work stations. The cycle time

is three minutes per item for every work station. This means that
Kanban card will be returned from any work station particular to the
previous work station, on average, every three minutes times the lot
size: What would be the impact of reducing lot sizes from ten units to
two? Using lot sizes of ten units and two units, average WIP
inventory levels and flow-through times are caculated. Solution: WIP
inventory levels: Lot size = 10: Average WIP = 5 work stations x 10
units/lot = 50 units Lot size = 2: Average WIP = 5 x 2 = 10 units
Process flow-through time (average) Lot size =10: Flow-through
time= 5 work stations x 10 units/ lot x 3 minutes / cycle= 150 minutes
Lot size = 2: flow-through time = 5 x 2 x 3 =-30 minutes In the
example, by reducing lot sizes from 10 units to 2 units, the CD
manufacturer was able to reduce WIP by a factor of 5 from 50 to 10
units, and flow-through time also by a factor of 5, from 150 to 30
minutes.
Many companies have experienced similar drastic improvements
through the introduction of Kanban. For this reason, they are able to
give better customer service and have lower investments in
inventories than do their competitors.
Kanban System at an American Toyota Motor FacilityThe plant
fabricated, assembled and painted four models of truck beds for
Toyota light trucks, with an annual capacity of 150,000 units a year.
The JIT implementation began in assembly area an then progressed
through manufacturing functions to a selected number of suppliers,
over a two year period. The system used material requirement
planning (MRP) for overall production planning and Kanban for shop
floor control. The salient feature of JIT application are : Company :
Toyota Motor Facility Product category : Truck beds Productivity
improvement : Labour- 20% Setup time reduction : Significant
Inventory reduction : Raw material - 21 % W IP - 45% Quality
improvement : Significant Space saving : Significant Others :
Warehousing cost reduced by 30%, Reduction in presses 30%,
Production volume up by 40%, 30% reduction in forklifts.
JIT in Process Type Industry JIT in Hand Blown Glass
Manufacture An application of JIT in a hand blown glass
manufacturing plant has been reported by Byrd and Carter. The JIT

production system was introduced in 1986. The objective was to
reduce the inventories. The overall impact of the project was : - Over
$ 750,000 in cost saving manufacturing - Reduction in manufacturing
cycle time of the glass from three weeks to 4 hours. - Reduction in
material flow through the plant by 81 %. - Release of over 1000 sq. ft.
of floor space for better use. –
Reduction in material handling by 7 moves in one product line and 4
moves in another product line. JIT Manufacturing at Avon Cosmetics
Avon Product Inc. is amongst the big gest producer of cosmetics in
the world. It is a direct selling enterprise and its high quality products
include cosmetics and fashion jewellery. Avon adopted JIT in 1982.
A trend prognosis system was setup for improving accuracy of the
sales forecasts. JIT oriented material disposition and purchasing were
brought about using long term contracts; frequent deliveries, approved
vendors and vendor rating schemes.
Introduction of Quality and Productivity Improvement
Programme (QPIP) worldwide resulted in many quantity and
productivity improvement system. Results obtained over a 5 years
period (1982-87) were as follows: - Reduction in inventory of
finished goods by 25%, Components (53%), raw ingredients (52%). -
Reduction in warehousing and handling cost (25%), reduction in
average run size (18%) and improvement in readiness to deliver (5.7)
JIT at Kawasaki Electricals ET was implemented at Kawasaki
Electric of Japan, a member of NPSRA, as a way to over come the
near bankruptcy condition of the company in 1982. Kawasaki
operated in the electrical switch board industry. Kawasaki began JIT
with a focus on orderlines and organisation leading to a plant clean up
campaign. The benefits derived were as follows : Space saving of
53,000 sq.ft. Overall workforce decreased by 157 over a four a four
year period.
Inventory
"Stocks" will cover finished goods stocks, but also raw materials,
work in process andcomponents ready for use. The term "Inventory"
refers to the stock of raw materials, Partsand finished products at hand
at a given time (a tangible asset which can be seen, weighed or
counted). In a wider sense "inventory consists of usable but idle

resources''. The resourcesmay be of any type; for example men,
materials, machines or money. When the resourceinvolved is material
or goods in any stage of completion, inventory is referred to as stock''.
Inventory consists of the following-
• Raw Materials: They are the physical resources to use in the
production of finishedgoods. The purpose of holding raw material is
to ensure uninterrupted production inthe event of delays in delivery
and to take advantage of bulk or other favorable termsof purchase.
Bought out components: Items not manufactured/fabricated by the
organization butused with or without further processing and/or
packing the finished product, e.g.Rubber parts by Egg co. Tin cans by
a Vanaspati Mill.
• Work in process- or intermediate goods are in the process of
production. Theirpurpose is to disconnect the various stages of
production which facilitate productionplanning. Such Inventory helps
to stabilize the rate of out put at successive stages inthe face of
fluctuation. Partly manufactured/processed inventories awaiting
furthermfg/processing between two operations and are in the process
of being fabricated orassembled into finished products, including
materials lying with subcontractors andmaterial lying in shop food for
further processing or assembly.
• Finished Goods: They are the inventory held for sale in ordinary
course of business.Such inventory serves as a buffer against
fluctuations in demand for a product. Stockof finished goods
facilitates a reasonable rate of out put and enables the firm toprovide a
quick service to customers. It helps to reduce the risk associated
withstoppages or reductions in production on account of strikes, break
down, shortage ofmaterial/power etc.
• MRO: Maintenance, Repair and operating supplies. The group
include spare partsand consumables which are required for use in the
process but do not form a part ofthe finished product, e.g. Lubricants,
V Belt, Electrodes, Pencil, Soap etc.
Inventory policies are important enough that production, marketing,
and financial managerswork together to reach agreement on these
policies. That there are conflicting viewsconcerning inventory
policies underscores the balances that must be struck among

conflicting goals-reduce production costs, reduce inventory
investment, and increase customer responsiveness.
WHY We Want to Hold Inventories? Inventories are necessary, but
the important issue ishow much inventory to hold. Below is the
summary and the reasons for holding finishedgoods, in-process, and
raw materials inventories.
Finished:
• Essential in produce-to-stock positioning strategies, of strategic
importance.
• Necessary in level aggregate capacity plans.
• Products can be displayed to customers.
In-Process:
• Necessary in process-focused production; uncouples the stages of
production;increases flexibility.
• Producing and transporting larger batches of products creates more
inventory but mayreduce materials-handling and production costs.
Raw Materials: Suppliers produce and ship some raw materials in
batches.
• Larger Purchases result in more inventory, but quality discounts and
reduced freightand materials handling costs may result.
In addition to the strategic importance in providing finished-goods
inventor so that customer
service is improved through fast shipment of customers' order, we
also hold inventories
because by doing so certain costs are reduced.
• Ordering costs. Each time we purchase a batch of raw material
from a supplier a costis incurred for processing the purchase order.
Expediting, record keeping andreceiving the order into the warehouse.
Each time we produce a production lot, achangeover cost is incurred
for changing production over from a previous product tothe next one.
The larger the lot sizes, the more inventory we hold, we order
fewertimes during the year and annual ordering costs are lower.
• Stockpot costs. Each time we run out of raw materials or finished-
goods inventorycots ma b incurred. In finished-goods inventory, stock
out costs can include sales anddissatisfied customers. In raw
materials, inventory, stock out costs can include thecost disruption to

production and sometimes even lost sales and dissatisfiedcustomers.
Additional inventory, called safety stock, can be carried to
provideinsurance against excessive stock outs.
• Acquisition costs. For purchased materials, ordering larger batches
may increase rawmaterials inventories, but unit costs may be lower
because of quantity discounts andlower freight and materials-handling
costs. For produced materials, larger lot sizesincrease in process or
finished goods inventories, but average unit costs may be
lowerbecause changeover costs are amortized over larger lots.
• Start-up quality costs. When we first begin a production lot, the
risk of defectives isgreat. Workers may be learning, materials may not
feed properly, machine settingsmay need adjusting, and a few
products may need to be produced before conditionsstabilize. Larger
lot sizes mean fewer changeovers as per year and less scrap.
Inventories can be indispensable to the efficient and effective
operation of productionsystems. But there are good reasons why we
do not want to hold inventory.
Why We Do Not Want To Hold Inventories: Certain costs increase
with higher levels ofinventories:
• Carrying costs: Interest on debt, interest income foregone,
warehouse rent, cooling,heating, lighting, cleaning, repairing,
protecting, shipping, receiving, materials-handling, Taxes, insurance
and management are some of the costs incurred to insure,finance,
store, handle and manage larger inventories.
• Cost of Customer responsiveness: Large in -process inventories
clog productionsystems. The time required to produce and deliver
customer orders is increased, andour ability to respond to changes in
customer orders diminishes.
• Cost of coordinating production: Because large inventories clog
the productionprocess, more people are needed to unsnarl traffic jams.
Solve congestion-relatedproduction problems, and coordinate
Schedules.
• Cost of diluted return on investment (ROI): Inventories are
assets, and largeinventories reduce return on investment, reduced
return on investment adds to thefinance costs of the firm by increasing
interest rates on debt and reducing stock prices.

• Reduced-capacity costs: Inventory represents a form of waste.
Materials that areordered, held, and produced before they are needed
waste production capacity.
• Large-lot quality cost: producing large production lots results in
large inventories.On rare occasions, something goes wrong and a
large part of a production lots adefective. In such situation, smaller lot
sizes can reduce the number of defectiveproducts.
• Costs of production problems: Higher in - process inventories
camouflageunderlying production problems. Problems like machine
breakdowns, poor productquality and material shortages never get
solved.At first, these costs may seem indirect, fuzzy and even
inconsequential, but reducing these costs by holding fewer inventories
can be crucial in the struggle to complete for world markets.
Nature of Inventories: Two fundamental issues underline all
inventory planning:
• How much to order of each material when orders are placed with
either outsidesuppliers or production departments with organization.
• When to place the orders
The determination of order quantities, sometimes also called lot sizes,
and when to placethese orders, called order points, determine in large
measure the amount of materials isinventory at any given time.
Types of Inventory: Include the following mentioned below:
• Anticipation inventories: When a firm anticipates a rise in prices, it
may purchasein bulk quantities and hold the same until the prices rise.
Similarly, products havingseasonal demand (wool, umbrellas, fans,
etc.) need to be produced and stocked inanticipation of sales during
the season. These kinds of inventories are calledanticipation
inventories.
• Fluctuation inventories: Demand fluctuates over time and it is not
possible topredict it accurately. Business firms maintain reserve
stocks to meet unexpecteddemand and thereby to avoid the risk of
losing sales. These safety stocks are knownas fluctuation inventories;
there is a time gap between production and use of certainproducts.
The goods produced in one season are held in stock for sale and
usethroughout the year. Potato, wheat, rice, etc., are examples of such
commodities.

When the availability of raw materials is seasonal (e.g., cotton), bulk
stocks arepurchased for use throughout the year.
• Lot-size inventories: Goods are bought in large lots to get the
benefit of discount.The gods so purchased are stocked until sale or
use.
• Transportation inventories: Raw materials and finished goods are
sent from oneplace to another. Some amount of inventory is always in
transit. Longer thetransportation period, greater is the amount of
transportation inventories.The problem of inventory management
(inventory problem) deals with how manyunits/quantity of inventory
should be carried in stock. This problem requires a balancebetween
the risk of being out of stock and the cost of preparing inventory. Out
of stockinvolves the cost of idle men and machines, loss of customers,
etc. Too high inventories
involve risk of loss due to changes in demand, price, style,
technology, etc.
The objectivehere is to minimize the cost of holding inventory
without taking undue risks. Inventorydecision in an important
strategic decision because the level of inventories serves as a guidefor
production planning. Production and sales policies are closely
connected with inventory
policy. Too much inventory is a cause for alarm as it may result in the
failure of a business.
Too low inventory may result in loss of sales. Planning the inventory
level is one of the keyareas of business decision making. An
enlightened inventory policy has favorable effect onthe costs of
production.
The level of inventory depends upon several factors:
• The rate of inventory turnover, i.e., the time period within which
inventorycompletes the cycle of production and sales. When the
turnover rate is high,investment in inventories tends to be low.
• Durable products are more susceptible to inventory holding as the
risk of perishability and obsolescence is less. Perishable and fashion
goods are not stocked in large amounts. Thus, the type of product also
influences the inventory level.

• Under conditions of imperfect competition demand is uncertain and
stocks must be held if the firm wants to take advantage of profitable
sales opportunities. The optimum level of inventory will demand
upon the variability of sales and the cost-revenue relationship. The
level of inventory rises with increase in the difference between price
and marginal cost. Thus, market structure influences the level of
inventories.
• Economies of production runs also determine the inventory level.
Modern machinery is very costly and the cost of idle machine time is
considerable. therefore,every business firm likes to maintain sufficient
stock of raw materials to ensure uninterrupted production.
• There are certain costs of carrying stock. Some of these costs
(STORAGE costs,setup cost, change-over costs, costs of ordering,
spoilage and obsolescence costs) are directly measurable.
Costs of Holding Inventories: The building up and holding of
inventories involves severalcosts. First of all there is the procurement
cost. Procurement costs are of two types. Wheninventory is procured
from outside suppliers, it is known as the ordering cost
(expensesincurred on preparing and sending the purchase order).
When the inventory is self-suppliedby the businessman from his own
factory, it is called setup costs. Strictly speaking, setupcosts are
relevant in job order production only. Setup costs include all the costs
componentsof changing over the production process to manufacture
the ordered item. It also comprisescost of time lost in changing the
production process and clerical cost involved in sending anorder to
the production department.
Capital cost: It refers to the cost of the money tied up in inventory.
Such cost depends onthe prevailing market rate of interest. But in a
capital scarce country like India, market rateof interest is not a correct
indicator of capital cost. What is relevant is the opportunity cost(loss
of earnings of capital which could alternatively be utilized elsewhere).
Storage costs: Storage costs include rent of go down where
inventories are stored, clericalcosts of maintaining stock records, cost
of air-conditioning (if any) required to protect theinventory, cost of
night watchman, cost of insurance of inventory, etc.

Deterioration Costs: Any product or material is likely to deteriorate
if stored for a long time.In addition to actual deterioration, there may
be pilferage and obsolescence. Such loss isincluded in deterioration
costs. In case of overstock inventory may be left after its demandhas
terminated.Capital cost
Storage costs: Such overstock cost also represents loss in value.
Stock- out Cost: When the inventory is required in factory or for sale
to consumers and thecompany runs out of stock, it losses production
or sales. There is the cost of ideal machinetime, loss of man hours,
failure to supply goods to customers on time and the resulting loss
ofgoodwill. Thus there is a cumulative effect. All such costs are called
shortage or penaltycosts.
There are there aspects of inventory replenishment order - (1) the size
of each order (calledlot size or reorder quantity), number of orders
and the time between the placement and receiptof an order (known as
lead time).
Lead time: It refers to the interval between placing an order for a
particular item and itsactual receipt. Suppose, an order is placed for a
particular item on Ist January and thematerial is received on Ist
February. In this case the lead time is one month. Longer is thelead
time higher will be the average level of inventory.
Safety stock: It implies the stock of inventory held as a safety
measure against fluctuations indemand and lead time. Safety stock is
a function of lead time. The longer the lead time, thegreater the safety
stock. Safety stock is also known as buffer stock or minimum stock.
Safetystock should be differentiated from working stock. Safety stock
refers to the stock ofinventory which is supposed to take care of
shortages. On the other hand, working stockrefers to the inventory
generated by orders.
During a cycle of production, the inventory is depleted.While
determining the safety stock, reorder cost and reorder quantity should
be considered.The cost of reorder and the quantity to be reordered
depend upon the following factors:
The minimum level: The minimum level of inventory is decided by
taking intoaccount such factors as the usage value of the item, normal
lead time, the availabilityof substitutes, etc. After taking these factors

into consideration, a level has to bedetermined below which the stock
of inventory should not fall. This is called theminimums level of
inventory.
• The reorder point: The reorder point should obviously be the
minimum level plus asafety margin which is kept to ensure that
shortages (out of stock situation) do notoccur.
• The standard order quantity: In order to minimize the cost of
acquiring inventory,the size of order should be decided. Discount
offered by suppliers and transport costsshould be considered in
deciding this quantity.
• The maximum level: This level can be determined by adding up the
minimum levelof inventory and the standard order quantity.
Economic order Quantity or optimum order quantity is that size of
the order where totalinventory costs (holding costs + ordering costs)
are minimized. It is also known as"Economic Lot Size".
The EOQ approach is based on the following assumptions.
• Inventory is consumed at a constant rate.
• Costs do not vary overtime.
• Lead Time is known and constant.
• Order costs, holding costs and unit price are constant.
• Holding costs are proportional to value of stocks held, similarly,
order cost variesproportionately with price.
Total cost for managing inventory of an item depends upon 3 factors:
• Ordering cost (OC)
• Inventory Carrying Cost (ICC)
• Quantity Discounts (QD)
Ordering cost is the cost of placing one order. Total ordering cost per
order can bedetermined by estimating annual cost actually incurred
during the past one year againstfollowing elements:
• Salaries + Perks paid to all the employees in the purchase
department.
• Proportionate part of salary + perk of the executives and employees
of otherdepartments spending part of their time in making purchases.
This will includeaccounts personnel associated with purchase
department in evaluating quotations andmaking payments. Also QC
department engaged in inspection and testing ofpurchased items.
• Traveling expenses related to procurement
• Telephone, telegram, telex, postage and stationery relating to
procurement.
• Depreciation of accommodation (or rent of building) and equipment used
forprocurement.
• Insurance, power, water and other service charges relating to purchase
department.
• Any other cost (entertainment etc.) incurred for purchasing.
Inventory Carrying Cost (ICC): Inventory carrying cost is the cost of
holding inventory.Various elements of cost falling under this head are as
given below: -
• Interest loss/opportunity loss on the capital locked up in the form of
averageinventory.
• Salaries and perks of the employees engaged in the stores.
• Depreciation of accommodation (or rent of building) occupied by stored
and storesoffices.
• Depreciation of handling equipment, racks, furniture and other facilities
used instores.
• Obsolescence of items in stores.
• Deterioration, damage and pilferage of items during storage.
• Telephone, telex, postage and stationery used by stores.
• Handling expenses paid to contractors, transporters, etc.
• Insurance and taxes on stores.
• Electricity, oil, water and other service charges of stores.
• Any other cost relating to holding of stocks in the stores.
Economic order quantity is defined as the order quantity against which
total of OC and ICC isminimum. As shown in figure EOQ will be the
order quantity where both ICC and OC curves interest each other.
Mathematically this quantity is calculated by the followingformula: -
2AS
Q = CI
Where Q = EOQ
A = Annual Consumption of the item in units.
S = Ordering Cost in Rs.
I = Inventory carrying cost as a fraction of the Iv. Inv.
C = Unit cost of the item in Rs.
Material Resource Planning (MRP) has become a centerpiece for all
manufacturing system.The key to successful production and operations
management in a manufacturing company isthe balancing of requirements
and capacities. It's that simple and yet very challenging.To understand it is
essential and to practice it can be a lot of fun. Remember what you
aretrying to do: Meet the needs of your customers. How? By having the
product available whenit is wanted. In production management, we do this
by knowing planning ahead to have thecapacity available.
Material requirements planning (MRP) A system of planning and
scheduling the time phased
materials requirement for production operations.Planning for Materials
Needs: In recent years material requirements planning systems
havereplaced reactive inventory systems in many organizations. Managers
using reactive systemsask,” What should I do now? “Whereas managers
using planning systems look ahead andask," What will I be needing in the
future? How much and when?"Improved customer service and other
advantages come at a cost, however. They require a
system for accurate inventory and product buildup information. They also
require a realisticmaster production schedule (MPS) to specify when
various quantities of end items will be completed.
value analysis and value engineering: Value analysis and engineering are
philosophies, rather than techniques that can be applied to materials
productivity. Their intention is to question all facts of products and how
they are made, and to determine whether all costs incurred contribute to
the final value of the product. "Ten tests for value" have been determined
which ostensibly challenge all non-essential product characteristics and
operations. However, the following questions may be more relevant.
• Does every facet of the product produce value? Is ever one necessary?
• Do we use materials which are too expensive?
• Is every operation performed essential? Could nay operation be
combined with another? Why do we need to make the product in the way
we do? Are there cheaper ways?

MBA 2018
SUBJECT NAME:
CORPORATE FINANCE AND INDIAN
FINANCIAL SYSTEM

MBA206-18 Corporate Finance and Indian Financial System
Unit-I Introduction to Financial Management and Corporate Finance: Meaning,
nature, evolution, objectives, functions and scope of corporate finance. Interface
of financial management with other functional areas, environment of corporate
finance, functions and role of financial manager. Time Value of Money-
Introduction, types of cash flows, future value of single cash flow, multiple
flows and Annuity. Valuation of Securities: Concept of Valuation, Methods for
valuation of equity, debt and hybrid securities.
Unit-II Capital Structure Decision-Capital Structure Theories: Meaning and
features of capital structure decision, Net Income Approach, Net Operating
Income Approach, Traditional Approach, Modigliani-Miller Hypotheses with
special reference to the process of arbitrage and Agency Cost. Capital
Budgeting Decision: Nature of investment decisions; process of capital
budgeting, investment evaluation criteria: Discounted and Non-Discounted
Methods (Pay-Back Period, Average rate of return, Net Present Value, Benefit
Cost Ratio and Internal Rate of Return). Risk analysis in capital budgeting and
Capital rationing.
Unit-III Dividend Decision-: Issues in dividend decisions. forms of dividend,
theories of relevance and irrelevance of dividends. Management of Working
Capital: Meaning, nature, objectives and Approaches of Working Capital
(Conservative, Matching and Aggressive approaches), Static vs. Dynamic View
of Working Capital. Factors determining the amount and composition of
Working Capital .Methods for financing of working capital.
Unit-IV Introduction to Financial System: Overview, evolution of Indian
financial system. Structure and functions of Indian financial system. Financial
sector reforms-major reforms in the last decade. Financial Institutions:
Introduction to Reserve Bank of India, Securities and Exchange Board of India,
Insurance Regulatory and Development Authority of India, Introduction to
commercial banks, co-operative banks, NBFCs, insurance companies, mutual
funds, stock exchanges, commodity exchanges, and Depositories. Financial
Markets: Introduction, evolution, capital market and money market, functions
and operations of primary market and secondary market. Financial Instruments:
Shares, Debentures, Bonds, Money Market Instruments, Derivatives, Global
Depository Receipts, Foreign Currency Convertible Bonds

UNIT-1
Finance touches every aspect of our life and holds the key to all
activities. It has been described as the life blood of any business. The
blood in our body needs to be regulated to ensure smooth circulation
for healthy survival. Management of finance in a optimal manner is
inevitable for success of any business. The finance function has been
defined differently by different writers and differently over time.
According to G.L. Jones, the most simplest way of understanding
finance is to say that finance is what finance does. L.J. Gitman has
defined finance as the art and science ofmanaging money. The only
conclusion one may make with respect to finance is that it has a
marvelous ability to evoke different concepts in the minds of men.
Financial management means money management. Financial
management is concerned with the planning and controlling of the
financial resources of the business firm. The term financial
management has emerged from the generic discipline of management.
As an academic discipline, the subject of financial management has
undergone radical changes in relation to its scope, functions and
objectives. In the past, the financial management was confined to
raising of the funds and its procedural aspects. In the broader sense, it
is now concerned with the optimum use of financial resources in
addition to its procurement. Therefore, financial management is that
part of management which is concerned mainly with: 1. Fund Raising:
raising the right type of funds in the most economic and suitable
manner. 2. Use of Funds: using the funds in the most profitable and
safest possible manner. According to James Van Horne, “Financial
management connotes responsibility for obtaining and effectively
utilizing funds necessary for the efficient operation of an enterprise.”
According to I.M. Pandey: “Financial management is that managerial
activity which is concerned with the planning and controlling of the
firm’s financial resources”. Financial management provides the best
guide for future resource allocation by the firm. It performs
facilitation, reconciliation and control function in an organisation. It
permits and recommends investment where the opportunity is
greatest. Financial management produces relatively uniform
yardsticks for judging most of the enterprise’s operations and projects.

It is continually concerned with an adequate rate of return on
investment which is necessary to assure the successful survival of an
enterprise. The problem of attracting new capital and providing funds
for capital needs is solved if the return on investments is adequate.
Because it is continuing drawing attention to such matters, financial
management is essential to effective top management.
Definitions of Financial Management The simple definition of
Financial Management is `the ways and means of managing money’.
This statement can be further expanded to define Financial
Management: the determination, acquisition, allocation and utilization
of the financial resources with the aim of achieving the goals and
objectives of the enterprise. According to Archer and Ambrosia:
“Financial management is the application of the planning and control
functions to the finance function”. Joseph and Massie: “Financial
management is the operational activity of a business that is
responsible for obtaining and effectively utilizing the funds necessary
for efficient operation”. Raymond Chambers: “Financial management
may be considered to be the management of the finance function. It
may be described as making decisions on financial matters and
facilitating and reviewing their execution. It may be used to designate
the field of study which lie beneath these processes”.
SCOPE OF FINANCIAL MANAGEMENT All decisions that have
monetary benefit come under the purview of financial management.
There are basically, two approaches for understanding the scope of
financial management: one is traditional approach and the second one
is the modern approach. 1. Traditional approach: Traditional approach
views the scope of finance function in a narrow sense of arrangement
of funds by business firm to meet their financing needs. Hence, the
following three inter-related aspects of raising and administering
financial resources were covered : (a) Arrangement of finance from
institution; (b) Raising funds in the capital market through financial
instruments including the procedural aspects; (c) Legal and
accounting aspects involved for raising finance for the firm. The
traditional approach was criticized for the reasons: (a) It emphasis
only the issues relating to procurement of funds and ignored the issues
related to internal financial decisions.

(b) It focused only on the problems related to corporate entities
ignoring the non-corporate bodies. The scope of financial
management was confined only to a particular segment of business
enterprises. (c) It laid more emphasis on the onetime events (episode)
such as promotion, incorporation, reorganization, etc., taking place in
the corporate life of the concern/ignoring the day-to-day financial
problems of the concern. (d) The focus was more on long term
financing. Working capital management was considered to be outside
the purview of finance function. According to Solomon, the
traditional approach has ignored the central issues of financial
management which comprise the following: (i) Should the enterprise
commit capital funds to certain purpose? (ii) Do the expected returns
meet financial standards of performance? (iii) How should these
standards be set and what is the cost of capital funds to the enterprise?
(iv) How does the cost vary with the mixture of financing methods
used? Therefore, the traditional approach while ignoring the above
crucial aspects implied a very narrow scope for financial
management. These defects were taken care by the Modern approach.
2. Modern Approach: The2. Modern Approach: The traditional
approach focused on sources of funds and was too often largely
concerned with specific procedural details. Experts pointed out the
following two defects of traditional approach : (i) It does not
recognize the relationship between financing mix and the cost of
capital and fails to solve the problems relating to optimum
combination of finance, and (ii) It also fails to deal with the problems
relating to the valuation of the firm and the cost of capital. The
modern approach aims at formulating rational policies for the optimal
use, procurement and allocation of funds; unlike the traditional
approach which has focused only on the sources of funds and their
procedural details. The modern approach apart for covering the
acquisition of external funds; includes the efficient andwise allocation
of funds for various uses. Emphasis has shifted from a detailed
analysis, of operating procedures in the acquisition, custody and
disbursement of funds to the formulation of rational decisions on the
optimal use and allocation of funds. Financial decision making has
become fully integrated in more advanced companies with top

management policy formulation via capital budgeting, loan range
planning, evaluation of alternate uses of funds, and establishment of
measurable standards of performance in financial terms. In the words
of Solomon, a financial manager should know the following: (i) How
large should an enterprise be and how fast should it grow? (ii) In what
form should it hold its assets? (iii) What should be the composition of
its liabilities? Thus, the modern approach views the term
financialThus, the modern approach views the term financial
management in a broad sense and provides a conceptual and
analytical framework for financial decision making. Therefore,
financial management, in the modern sense of the term, can be related
to three major decision making areas. They are as follows: 1.
Investment Decision i.e. Where to invest funds and in what amounts?
2. Financing Decisions i. e .Where to raise funds from and in what
amount? 3. Dividend Decisions i. e How much of profits should be
paid by way of dividends and how much should be retained in the
business? All the above three decisions contribute towards the goal of
wealth maximization. 1. Investment Decisions: Investment decisions
involve identifying the asset or projects in which the firms limited
resources should be invested. It involves the major task of measuring
the prospective profitability of investment in assets of the company or
in new projects. The decisions relating to acquisition of fixed assets
investment are known as capital budgeting decisions and the decisions
relating to current assets investment are known as working capital
management decisions. Capital budgeting decisions relate to selection
of an asset or investment proposal or course of action which have hot
long termimplications on the cash flows and profitability of such
investment. It helps in judging whether it is financial feasible to
commit funds in future. An important aspect of working capital, the
profitability would be adversely affected, whereas with too inadequate
working capital, it would be unable to meet its 6 financial
commitment on time and thereby invite the risk of insolvency. The
investment in the fixed assets of the company determines the
production capacity of the company. The production should be
sufficient to demand in the market. Production should not fall short or
be too excessive in relation to the demand for the product in the

market. Further, the fixed assets must be productive enough to ensure
the returns expected from such investment. This should be supported
by sufficient investment in the working capital assets. The working
capital assets should be adequate enough to maintain sufficient
liquidity to augment the sales level. Investment decisions yield returns
in future. Future performance is subject to uncertainty and risk.
Therefore, investment decisions require careful analysis before
substantial amounts are committed in fixed assets. The investment
decisions having long term implications and affects the cash inflows
in the years to come. Hence any wrong decision taken in the initial
year, would adversely affect the future profitability and growth.
Hence appropriate techniques need to be adopted for proper
evaluation of investment decisions. 2. Financing Decisions: Financing
decisions involve deciding on the most cost effective method of
financing the chosen investments. Financing decisions relate to the
financing pattern of the firm. It involves in deciding as to when,
where and how to acquire the funds to meet the firm’s investment
needs. Different sources of finance have different advantages with
different degree of risks. Hence it becomes imperative to decide as to
how much finance is to be raised and from which sources. The prime
objective being to keep the cost of finance at the minimum with
maximum utilization of funds. Primarily, there are two main sources
of finance: one is the owned funds and second is the borrowed funds.
Owned funds are the shareholder’s monies on which dividend are
paid. Dividend payment depends upon the profitability of the
company and is not binding. There is no commitment involved in the
shareholders funds. On the other hand, borrowed funds involve fixed
commitments; their repayments are secured by a charge created on the
assets and interest payments are obligatory irrespective of the profits
or losses of the company. Hence, it increases the financial risk of the
company. The borrowed funds are relatively cheaper, but entail a
certain degree of risk, therefore, due prudence must be exercised
while determining the mix of owned and borrowed funds. 3. Dividend
Decision: Dividend Decisions involve the decisions as regards what
amount of profits earned should be distributed by way of dividends
and what amount should be retained in the business. Dividend policy

is to be decided having regard to it’s 7 implicate on the shareholder
wealth in the firm. The aim is to decide an optimum dividend policy
which would maximize the market price of shares. This is a crucial
decision as it determines the reputation of the management of the
company and therefore, the market value of the shares. If the
management decides to retain profits, it should be able to generate
adequate returns (by investing such retained profits), which should be
much more that what the, shareholders could have got, had they
received the dividends and invested the amount elsewhere. If the
management is not able to generate adequate returns on reinvestment
of retained profits, then it should prefer to pay dividends rather than
retaining the profits. Therefore, the two important factors which
affects the dividend decisions are: firstly, the investment opportunities
available to the firms and secondly, the opportunity rate of return of
the shareholders. The topic has been dealt in more details in the
subsequent chapters of this book. 1.4 IMPORTANCE OF
FINANCIAL MANAGEMENT IN BUSINESS The importance of
financial management is known from the following aspects: 1.
Applicability – The principles of finance is applicable wherever there
is cash flow. The concept of cash flow is one of the central elements
of financial analysis, planning, control and resource allocation
decisions. Cash flow is important because financial health of the firm
depends on its ability to generate sufficient amounts of cash to pay its
employees, suppliers, creditors and owners. Any organization,
whether motivated with earning of profit or not, having cash flow
requires to be viewed from the angle of financial discipline.
Therefore, financial management is equally applicable to all forms of
business like sole traders, partnerships, companies. It is also
applicable to non profit organizations like trusts, societies,
governmental organizations, public sector enterprises etc. 2. Chances
of Failure – A firm having latest technology, sophisticated machinery,
high caliber marketing and technical experts etc. may fail to succeed
unless its finances are managed on sound principles of financial
management. The strength of business likes in its financial discipline.
Therefore, finance function is treated as primary, which enable the
other functions like production, marketing, purchase, personnel etc. to

be more effective in achievement of organizational goals and
objectives. 8 3. Return on investment – Anybody invests his money
will mean to earn a reasonable return on his investment. The owners
of business try to maximize their wealth. It depends on the amount of
cash flows expected to be generated for the benefit of owners, the
timing of these cash flows and the risk attached to these cash flows.
The greater the time and risk associated with the expected cash flow,
the greater is the rate of return required by the owners. The Financial
management study the risk-return perception of the owners and the
time value of money. 1.5 QUALITIES OF A SUCCESSFUL
FINANCE MANAGER The job of a finance manager is full of duties
and responsibilities. He has to perform various duties connected with
finance. In order to perform the finance duties successfully, a finance
manager should be competent. He should possess the following
qualities: 1. Personality is the sum total of physical and mental
qualities. A finance manager should have a pleasing personality.
Good height, good physique, good appearance would be an asset to a
finance manager. He should be physically and mentally healthy
enough to bear the strain of finance in an organization. 2. The job of a
finance manager involves analytical work. He should have a high
degree of intelligence to understand the finance problems
immediately. An intelligent finance manager can control the finance
properly. 3. A finance manager should take initiative in performance
of work. He should do the job at his own i.e. without being told by
others. 4. A finance manager should have vast fund of power of
imagination to his credit. He should have a research mind which is
very creative. He should be able to bring innovation in financial
management of an organization. 5. A finance manager should have
self confidence to face the challenges involved in his job. 6. A finance
manager is a leader of financial administration. He should have an
effective Communication Skill. He should understand the problems of
his subordinates and communicate instructions to solve them. 9 7. The
job of a finance manager involves decision making. He has to take
various decisions which have financial implications on the working of
the organization. He should have the quality to judge the situation and
take right decision accordingly. 8. He should be honest in his job.

Finance requires utmost honesty on the part of the manager and the
subordinates also. 9. He should have an administrative skill to
administer the finance function. He should be able to plan, organize,
direct, control and coordinate the activities of the finance area. He has
to see that the financial decisions are properly implemented. 10. A
finance manager should be self-disciplined. He should be able to
enforce discipline in the organization. 11. A finance manager should
have patience. He should not take hasty decisions which have adverse
impact on the financial health of the organization. He should listen to
the views of others. 1.6 FUNCTIONS OF FINANCIAL
CONTROLLER The important functions of a Financial controller in a
large business firm consist of the following: 1. Provision of Capital –
To establish and execute programmes for the provision of capital
required by the business. 2. Investor Relations – To establish and
maintain an adequate market for the company’s securities and to
maintain adequate liaison with investment bankers, financial analysis
and shareholders. 3. Short-term Financing – To maintain adequate
sources for company’s current borrowing from commercial banks and
other lending institutions. 4. Banking and Custody – To maintain
banking arrangement, to receive, have custody of and disburse the
company’s monies and securities. 5. Credit and Collections – To
direct the granting of credit and the collection of accounts due to the
company, including the supervision of required special arrangements
for financing sales, such as time payment and leasing plans. 6.
Insurance – To provide insurance coverage as required. 10 7.
Investments – To achieve the company’s funds required and to
establish policies for investment in pension and other similar trusts. 8.
Planning for Control – To establish, coordinate and administer an
adequate plan for the control of operations. 9. Reporting and
interpreting – To compare performance with operating plans and
standards, and to report and interpret the results of operations to all
levels of management and to the owners of the business. 10.
Evaluating and Consulting – To consult with all segments of
management responsible for policy or action concerning any phase of
the operation of the business as it relates to the attainment of
objectives and the effectiveness of policies, organization structure and

procedures. 11. Tax Administration – To establish and administer tax
policies and procedures. 12. Government Reporting – To supervise or
coordinate the preparation of reports to government agencies. 13.
Protection of Assets – To ensure protection of assets for the business
through internal control, internal auditing and proper insurance
coverage. 14. Economic Appraisal – To appraise continuously
economic, social forces and government influences, and to interpret
their effect upon the business. 15. Managing Funds – To maintain
sufficient funds to meet the financial obligations. 16. Measuring of
Return – To determine required rate of return for investment
proposals. 17. Cost control – To facilitate cost control and cost
reduction by establishment of budgets and standards. 18. Price Setting
– To supply necessary information for setting of prices of products
and services of the concern. 19. Forecasting Profits – To collect
relevant data to make forecast of future profit levels. 20. Forecast
Cash flow – To forecast the sources of cash and its probable payments
and to maintain necessary liquidity of concern. 11 1.7 GOALS /
OBJECTIVES OF FINANCE MANAGEMENT Many of the well
known authors on the subject have highlighted the following two
important goals of financial management. They are as follows: 1.
PROFIT MAXIMIZATION: The objective of making profit is a
commercial imperative. Profit generation is essential for survival and
growth of the business. Profit generation is also regarded as a measure
of success of the business. Profit is an important yardstick for
measuring the economic efficiency of any firm. Any business would
be making the use of economic and human resources available to
generate profits. The cost of these resources is required to be met
from the revenue generated from the use of these resources and the
surplus remaining would be needed for the growth and expansion of
the company. It is only an efficiently run business which can afford to
meet the cost of resources and generate profits. Therefore, the survival
and growth of any business depends upon its ability in earnings
profits. It is therefore contended that profit maximization is one of the
primary goals of the organization without which the survival of the
organization itself is threatened. x THE DRAWBACKS OF THE
GOAL OF PROFIT MAXIMIZATION Although profit is an

important yardstick for measuring the economic efficiency of any
firm, yet it has got certain limitations which are listed below: 1. It
ignores the risk which is associated with the investment in such
profitable ventures. It ignores the risk or uncertainly of expected
returns or benefits. Risk is defined as the chance that the actual
outcome of a decision may differ from the expected outcome and in
finance; risk investment is one whose potential returns are expected to
have a high degree of variation or volatility. Some with an investment
with high profits potential but having a high degree of risk. When
profit maximization is aimed as the main objective, all profitable
investment projects are accepted without having regard to the risk
factor. An investment may have profit potential but may not be worth
the risk. 2. The objective of profit-maximization assumes the
existence of perfect market conditions in which various resources are
efficiently managed. However, modern markets suffer from many
imperfections. It leads to inequitable distribution of income and
wealth. 12 3. It ignores the time value of money without having any
regard to the timings of costs and returns. It takes into account only
the size of the profits without considering the timings of the
prospective earnings. 4. Profit maximization as an objective is
considered to be vague and ambiguous. It does not define adequately
as to what profits are, what profits to be considered, whether from the
point of view of funds employed or from the shareholders point of
view, or short term or long term profits etc. 5. Profit maximization as
an objective ignores other important aspects of financing e.g.
borrowing capacity etc. 6. The objective of profit maximization
focuses on interests of the owners alone and ignores the interest of
other interested parties such as employees, consumers, government
and society in general. 7. The perception of the management as
regards profit maximization substantially differs from the perception
of the shareholders. Another variant of profit maximization is to
consider the rate of return on investment. If the rate of return on
investment is higher than the cost of funds, then such investment
opportunities can be undertaken. 2. Wealth Maximisation: According
to this objective, the owners of the company i.e. the shareholders are
more interested in maximizing their wealth rather than in profit

maximization. Maximization of the wealth of the shareholders means
maximizing the net worth of the company for its shareholders. This
reflected in the market price of the shares held by them. Therefore,
wealth maximization means creation of maximum value for
company’s shareholders which mean maximizing the market price of
the share. Wealth maximization refers to the gradual increase in value
of the net assets of the organization. Profit generation adds to the
increase in the value of the net assets of the organization. With greater
profits, the EPS (earnings per share) goes up; resulting an increase in
the value of the net assets belonging to the shareholders of the
company. The market price of the shares is an important indicator of
the wealth maximization of the organization. Wealth maximization is
the net present value of a financial decision. Net present value is the
difference between the gross present value of the revenue generated
from such decision and the cost of such decision. A financial action
with a positive net present value creates wealth and therefore is
desirable. The total cash inflows over the years in terms 13 of present
value must be greater the outflows of cash invested for generating
such cash inflows. This results in financial advantage leading to
increase in the value of net assets. The increase in the value of net
wealth should in turn help in generating greater volume of profits.
This action results in financial gains to the shareholders increasing the
earnings per share. Prof. Solomon has suggested wealth maximization
as the best criterion. According to him “Wealth or net present worth is
the difference between gross present worth and the amount of capital
investment required to achieve the benefits. Any financial action
which creates wealth or which has a net present worth above zero is a
desirable one and should be undertaken. Any financial action which
does meet this test should be rejected”. Solomon states that wealth
maximization provides an unambiguous measure of what financial
management should seek to maximize in making investment and
financing decisions. Future earnings of a company are subject to
uncertainties and exposed to risk. Financial decisions for which the
consequences are known at a later date may either result in increasing
or decreasing the net wealth of the shareholders. Unforeseen
economic and social conditions may adversely affect the company.

Hence the process of wealth generation is a difficult task. Therefore,
the goal of wealth maximization implies a long term perspective of
the goal. The interest of the management in maximizing the market
price of the share is compatible with that of the shareholders’ interest.
This helps the management in allocating the resources in the best
possible manner balancing the risks and the returns. x THE MERITS
OF THE GOAL OF WEALTH MAXIMIZATION ARE AS
FOLLOWS: 1. It is a very effective and meaningful criterion to
measure the performance of the company. 2. The objective of wealth
maximization is consistent with the objective of maximization of the
shareholders’ economic welfare. 3. The objective is also consistent
with the objective of perpetual survival of the company and its long
term profitability. 4. It is operationally feasible and logical. 14 5. It
includes the motive of profit maximization as it emphasis on
maximization of long term profitability and ensures maximum return
on owners investment. 6. The objectives allow for timings of profits
and also consider the timings of perspective benefits. 7. It ensures fait
return on the investments, and takes into account the uncertainty of
the benefit also. 8. It offers rational guidelines for effective use of the
resources available. x THE DRAWBACKS OF THE GOAL OF
WEALTH MAXIMIZATION (i) The basic assumption is that there
an efficient capital market wherein the market price of the share is
truly reflected. This assumption seldom holds in real practice. (ii) The
market price is influenced by various economic and political factors
which are difficult to anticipate and judge. (iii) The various parties
having their stake in the company have conflicting interests and
therefore difficult to reconcile their divergent views. 3. OTHER
GOALS OR OBJECTIVES OF FINANCIAL MANAGEMENT: (i)
To ensure adequate returns to the shareholders which should be fair in
the given market conditions. (ii) To contribute to the operational
efficiency of all other areas of management. (iii) To infuse financial
discipline in the organization. (iv) To build up a strong financial base
so that the enterprise can fall back upon its reverses during lean years
and withstand the shocks of the business. 1.8 EXERCISES 1. Define
the scope of financial management. What role should the financial
manager plan in the modern enterprise ? 2. How should the finance

function of an enterprise be organized ? What functions are performed
by the financial officers ? 3. State the scope of Financial
Management. 15 4. State and explain the main functions of a finance
manager. 5. Explain the role of finance manager in a large corporate
enterprise. 6. What are the functions of Financial Management? 7.
`The goal of profit maximization does not provide us with an
operationally useful criterion.” Comment. 8. What is objective of
profit maximization pool? How is its different from objective of profit
maximization? 9. How does the modern finance manager differ from
the traditional finance manager? 10. Discuss the contents of modern
finance functions. 11. Discuss the nature and scope financial
management. 12. Discuss the nature of financial management. It it a
staff of line function ? 13. Describe the functions of finance. In what
ways, are these functions related to possible finance objectives of a
company ? 14. Explain the nature and scope of finance function. What
are the basic objectives of decision-making in corporate finance ? 15.
Discuss the functions of a Chief Financial Officer. Multiple Choice
Questions (1) The investment decisions should aim at investment in
assets only when they are expected to earn a return greater than a
minimum acceptable return is termed as ……………………. (a)
Interest rate (c) growth rate (b) Hurdle rate (d) internal rate of return
(2) The traditional view of financial management looks at : (a)
Arrangement of short-term and long-term funds from financial
institutions. (b) Mobilization of funds through financial instruments.
(c) Orientation of finance functions with accounting function. (d) All
of the above (3) The modern approach to Financial management view
: (a) the total funds requirement of the firm (b) the assets to be
acquired (c) the pattern of financing the assets. (d) All of the above 16
(4) The financing of long-term assets should be made from : (a) Short-
term fund (c) long-term funds (b) Debt funds (d) equity funds (5) In
fund raising decisions, one should keep in view : (a) Cost of various
funds and financial risk. (b) Advantages and disadvantages of debt
component in capital mix. (c) Impact of taxation on EPS (d) All of the
above. (6) The financial health of the firm depends on its ability to
generate sufficient _____ to pay its employees, suppliers, creditors
and owners : (a) Profit (c) growth (b) Cash (d) wealth (7) Liquidity

and profitability are _______ goals for the Finance manager. (a)
Different (c) competing (b) Separate (d) finance (8) Wealth
maximization means maximizing the ____ of a course of action. (a)
NPV (c) profit (b) IRR (d) growth (9) _________ maximization
objective considers the risk and time value of money. (a) Profit (c)
value (b) Wealth (d) growth ™™™™ 17 2 TIME VALUE OF
MONEY Unit Structure : 2.0 Objectives 2.1 Introduction 2.2 Time
Value of Money 2.3 Basic Concepts 2.4 Time Value of Money
Relationship 2.5 Future Value of Single Amount 2.6 Future Value of
Annuity 2.7 Doubling Period 2.8 Present Value of an Uneven Series
of Payments 2.9 Present Value of Annuity 2.10 Net Present Value
2.11 Mathematical Tables 2.12 Exercise 2.0 OBJECTIVES After
going through this chapter, you will able to: x Understand the concept
of time value of money x Compute the time value of money x
Calculate the future value as well as the present value of money x
Understand the concept of present value and future value of annuities
2.1 INTRODUCTION : In our economics life, money is not free.
Money has time value. Interest rates give money its time value. If the
investor has some spare cash or funds, he can invest it in savings
deposit in a bank and receive more money later. If the investor wants
to borrow money, he must repay a larger amount in the future due to
interest. The result is that Rs. 100 in hand today, is worth more than
Rs. 100 to be received a year from now. This is because Rs. 100 today
can be invested to provide Rs. 100 plus interest after a year. The
interest rates in the economy provide money with its time value.
There are two types of decisions which requires some consideration of
time value. The first decision involves investing 18 money now in
order to receive future cash benefits. The other decision involves
borrowing now to take current expenditure at a cost of having less
money in the future. The intelligent investor requires familiarity with
the concepts of compound interest. 2.2 TIME VALUE OF MONEY :
In the world of finance and investment, time does have a value, Rs.
100 today are more valuable than Rs. 100 a year later. This is because
capital can be employed productively to generate positive returns.
Again, individuals normally prefer current consumption to future
consumption. Even in case of inflation, Rs. 100 today represent

greater real purchasing power as compared to Rs. 100 one year later.
The longer the term of a loan, the greater the amount that must be
paid due to interest. Bonds are worthless to an investor, if the maturity
is longer. Therefore, this makes sense under the general framework of
the time value of money. 2.3 BASIC CONCEPTS : (a) PRESENT
VALUE : A present value is the discounted value of one or more
future cash flows. (b) FUTURE VALUE : A future value is the
compounded value of a present value. (c) DISCOUNT FACTOR :
The discount factor is the present value of a rupee received in the
future. (d) COMPOUNDING FACTOR : The compounding factor is
the future value of a rupee. Discount and compounding factors are
functions of two things : (i) the interest rate used, and (ii) the time
between the present value and the future value. The discount factor
decreases as time increases. The discount factor also decreases as
interest rate increases. 2.4 TIME VALUE OF MONEY
RELATIONSHIP : The basic time value of money relationships are
presented in the following equations : (1) PV = FV x DF (2) FV = PV
XCF Whereas, PV = Present value 19 FV = Future value DF =
Discounting factor = 1 (1 + R)t CF = Compounding factor = (1 + R)t
R = Rate of interest T = time in years. 2.5 FUTURE VALUE OF
SINGLE AMOUNT : The future value of an amount invested or
borrowed at a given rate of interest can be calculated if the maturity
period is given. Suppose, a deposit of Rs. 5,000 gets 10 percent
interest compounded annually for a period of 3 years, the future value
will be: PV X CF = 5,000 (1.10)3 = 5,000 x 1.331 = Rs. 6,655.
Illustration 1: Shashikant deposit Rs. 1, 00,000 with a bank which
pays 10 percent interest compounded annually, for a period of 3 years.
How much amount he would get a maturity? Solution FV = PV X CF
= 1,00,000 x (1.10)3 = 1,00,000 x 1.331 = Rs. 1,33,100 Mr.
Shashikant will get Rs. 1,33,100 after 3 years. 2.6 FUTURE VALUE
OF ANNUITY : An annuity is a series of payments of a fixed amount
for a specified number of periods. When payment are made at the end
of each year, it is called ordinary annuity. On the other hand when the
payments are made at the beginning of the year, it is called an annuity
due. Normally, it is assumed that the first annuity payment occurs at
the end of the first year. (1 + R)t – 1 FVa = A --------------- R Where

A = Periodic cash payments R = Annual interest rate T = time in years
/ duration of annuity The value of (1+R)t – 1 can be determined by
using the Time value of money tables. R The Future value Interest
Factors (FVIFA) for various years are a shown in table: 20 Year FVIF
@ 8% FVIF @ 10% FVIF @ 12% FVIF @14% 1 1,0000 1,0000
1,0000 1,0000 2 2,0800 2,1000 2,1200 2,1400 3 3,2464 3,3100
3,3744 3,4396 4 4,5061 4,6410 4,7793 4,9211 5 5,8666 6,1051
6,3528 6,6101 6 7,3359 7,7156 8,1152 8,5355 7 8,9228 9,4872
10,089 10,730 8 10,636 11,435 12,299 13,232 9 12,487 13,579
14,775 16,085 10 14,486 15,937 17,548 19,337 Illustration 2: Four
equal annual payments of Rs. 5,000 are made into a deposit account
that pays 8 percent interest per year. What is the future value of this
annuity at the end of 4 years ? Solution (1 + R) t – 1 The future value
of annuity FVa = A R = Rs. 5,000 x FVIFA @ 8% = Rs. 5,000 x
4.5061 = Rs. 22530.50. 2.7 DOUBLING PERIOD Sometimes,
investor should know how long it will take to double his money at a
given rate of interest. In this case, a rule of thumb called the rule of
72, can be used. This rule works pretty well for most of the interest
rates. The rule of 72 says that it will take seventy-two years to double
your money at 1 percent interest. You can calculate the doubling by
dividing 72 by the interest rate. You can also estimate the interest rate
required to double your money in the given number of years by
dividing number of years into 72. For example, if the interest rate is
12 percent, it will take 6 years to double your money (72+23). On the
other hand, if you want to double your money in 6 years, the interest
rate should be 12 percent (72+6). 21 A more accurate method used for
doubling your money is using the rule of 69. According to this rule,
the doubling period of an investment is = 0.35 + 69 Thus the doubling
period of Interest rate investment of different rates of interest can be
determined as follows : (1) Interest rate 12% 69 0.35 + ----- = 0.35 +
5.75 = 6.1 years 12 (2) Interest rate 15% 69 0.35 + ----- = 0.35 + 4.60
= 4.95 years 15 Illustration 3 : If the interest rate is 10%, what are the
doubling periods of an investment at this rate ? Solution (a) As per
rule of 72, the doubling period will be 72 10 = 7.2 years (b) As per the
rule of 69, the doubling period will be 69 = 0.35 + 6.9 = 7.25 years
0.35 + 10. PRESENT VALUE : Many times, investors like to know

the present value which grows to a given future value. Suppose, you
want to save some money from your salary to but a scooter after 5
years. You should know how much money should be put into bank
now in order to get the future value after 5 years. The present value is
simply the inverse of compounding used in determining future value.
The general relationship between future value and present value is
given in the following formula : PV = FV x DF = FV X 1 (1+R
Illustration 4 : Find the present value of Rs. 50,000 to be received at
the end of four years at 12 percent interest compounding quarterly.
PV = FV 1 PV = FV x PVIF at 12% = Rs. 50,000 x 0.623 = Rs.
31,150 22 2.8 PRESENT VALUE OF AN UNEVEN SERIES OF
PAYMENTS : The annuity includes the constant amount in which
cash flows are identical in every period. Many financial decisions
involve constant cash flows, however, some important decisions are
concerned with uneven cash flows. For example, investment in shares
is expected to pay an increasing series of dividends over time. The
capital budgeting projects also do not normally provide constant cash
flows. In order to deal with uneven payment streams, we have to
multiply each payment by the appropriate PVIF and then sum these
products to obtain the present value of an uneven series of payments.
Illustration 5: Mr. Shah has invested Rs. 50,000 on Xerox machine on
1st Jan. 2002. He estimates net cash income from Xerox machine in
next 5 years as under. Year Estimated inflows 2002 12,000 2003
15,000 2004 18,000 2005 25,000 2006 30,000 At the end of 5th year
Machine will be sold at Scarp value of Rs. 5,000. Advice him whether
his project to viable, considering interest rate of 10% p.a. Solution
Calculation of Present Value of Future Cash Flows : Year Inflows
(Rs) PVIF at 10% PV of Inflows (Rs.) 2002 12,000 0.9091 10909
2003 15,000 0.8264 12396 2004 18,000 0.7513 13523 2005 25,000
0.6830 17075 2006 2006 30,000 5,000 0.6209 21732 75635 23 Note :
It is assumed that the net cash income is received at the end of the
year. Considering 10% interest rate, the net present value of all future
cash flows is Rs. 75,635 which is higher than present net cash flow of
Rs. 50,000. Thus, the project is viable. 2.9 PRESENT VALUE OF
ANNUITY : Many times investors want to know the present value
which must be invested today in order to provide an annuity for

several future periods. For example, A grandfather wants to deposit
enough money today to meet the tuition fees of his grand-son for the
next three years. The interest rate is 8%. The present value of this
annuity is the sum of the present values of all the future inflow of the
annuities. The present value of an annuity can be expressed in the
following formula :
1+R t - 1 = R 1+R t Where PVA1 = Present value of an annuity with
a duration of `t’ periods A = Constant periodic flow R = Interest Rate
The present value interest factors for an annuity (PVIF) can be
determined by using the Time Value of Money Tables. The (PVIF)
for various years are given below: Year PVIF @ 8% PVIF @ 10%
PVIF @ 12% PVIF @ 14% 1 0.9259 0.9091 0.8929 0.8772 2 1.7833
1.7355 1.6901 1.6467 3 2.5771 2.4869 2.4018 2.3216 4 3.3121
3,1700 3.0373 2.9140 5 3.9927 3.7908 3.6048 3.4331 6 4.6229
4.3553 4.1114 24 For all positive interest rates, PVIFA for the present
value of an Annuity is always less than the number of periods the
annuity runs, whereas FVIFA for the future value of an annuity is
equal to or greater than the number of periods. Illustration 6 : What is
the present value of a 4 years annuity of Rs. 8,000 at 12% interest ?
Solution (1+R)t – 1 PVA = A R(1+R)t The value of (1+R)t – 1 as per
table is 3.0373 R(1+R)t = Rs. 8,000 x PVIF at 12% = Rs. 8,000 x
3.0373 = Rs. 24.298 2.10 NET PRESENT VALUE : Net Present
Value (NPV) is the most suitable method used for evaluating the
capital investment projects. Under this method, cash inflow and
outflows associated with each project are worked out. The present
value of cash inflows is calculated by discounting the cash flows at
the rate of return acceptable to the management. The cash outflows
represent the investment and commitments of cash in the project at
various points of time. It is generally determined on the basis of cost
of capital suitably adjusted to allow for the risk element involved in
the project. The working capital is taken as a cash outflow in the
initial year. The cash inflow represents the net profit after tax but
before depreciation.A depreciation is a non-cash expenditure hence it
is added back to the net profit after tax in order to determine the cash
inflows. The Net Present Value of cash inflows and the present value
of cash outflows. If the NPV is positive the project is accepted, and if

it is negative, the project is rejected. Discounted cash flow is an
evaluation of the future net cash flows generated by a project. This
method considers the time value of money concept and hence it is
considered better for evaluation of investment proposals. If these are
mutually exclusive projects, this method is more useful. The Net
Present Value is determined as follows : NPV = Present value of
future cash inflows – Present value of cash outflows. 25 llIustration7 :
An investment of Rs. 40,000 made on 1/4/2002 provides inflows as
follows : Date Alternative I Alternative II 01/04/03 20,000 10,000
01/04/04 10,000 20,000 01/04/05 10,000 10,000 01/04/06 10,000
10,000 Which alternative would you prefer in the investor’s expected
return is 10%? Give reason(s) for your preference. Solution
Calculation of Present Values : Alternative I Date Amount Discount
Factor PV (Rs) 01/04/03 20,000 0.9091 18182 01/04/04 10,000
0.8264 8264 01/04/05 10,000 0.7513 7513 01/04/06 10,000 0.6830
6830 40,789 Alternative II Date Amount Discount Factor PV (Rs)
01/04/03 10,000 0.9091 9091 01/04/04 20,000 0.8264 16528 01/04/05
10,000 0.7513 7513 01/04/06 10,000 0.6830 6830 39,962 The net
present value of all future cash flows is Rs. 40,789 in case of
Alternative I and Rs. 39,962 in case of II. The NPV in 26 case of
alternative I is higher at 10% discounting factor. Hence, alternative I
is preferred for investment. Illustration 8 : A Finance company has
introduced a scheme of investment of Rs. 40,000. The returns would
be Rs. 8000, 10000, 11000 and 12000 in the next five years. The
indicated rate of interest is 10% Compute the present value of the
investment and advise regarding the investment. Solution : (i) Present
value of investment = Rs. 40,000. (ii) Present value of returns : Year
Returns (Rs) PVIF (10%) Present Value (Rs.) 1 8,000 0.9091 7273 2
9,000 0.8264 7438 3 10,000 0.7513 7513 4 11,000 0.6830 7513 5
12,000 0.6209 7451 37188 (iii) Present value of investment is Rs.
37,188 which is lower than investment of Rs. 40,000. The net present
value (i.e. 37,188-40,000 = Rs. 2,812) is negative. Hence the
investment is not profitable at 10% interest. Illustration 9 : The share
of Ridhi Ltd (Rs.10) was quoting at Rs. 102 on 01.04.2002 and the
price rose to Rs. 132 on 01.04.2005. Dividends were received at 10%
on 30th June each year. Cost of funds was 10%. Is it a worth-while

investment, considering the time value of money ? (Present value
factor at 10% were 0.909, 0.826 and 0.751). 27 Solution Calculation
of Present Value of Cash inflows : Year Inflow (Rs) Present Value
Factor Present Value (Rs.) 1 1 0.909 0.909 2 1 0.826 0.826 3 1 + 132
= 133 0.751 99.883 Present Value 101.618 (-) Present Value of Cash
Outflow 102.000 Net Present Value -0.382 Considering the time
value of money, the NPV is negative, hence, it is not a wise
investment. Illustration 10 : XYZ & Co. is considering investing in a
project requiring a capital outlay of Rs. 2,00,000. Forecast for annual
income after tax is as follows: Year 1 2 3 4 5 Profit After Tax (Rs.)
1,00,000 1,00,000 80,000 80,000 40,000 Depreciation is 20% on
Straight line Basis Evaluate the project on the basis of Net Present
Value taking 14% discounting factor and advise whether XYZ & Co.
should invest in the project or not ? The Present value of Re. 1 at 14%
discounting rate are 0.8772, 0.7695, 0.6750, 0.5921 and 0.5194.
Depreciation = 20% of 2,00,000 = Rs. 40,000 Profit after tax is given.
The cash inflow after tax (CFAT) = Profit After Tax (PAT +
Depreciation. 28 Year PAT + Depreciation CFAT DF P.V. 1 1,00,000
40,000 1,40,000 0.8772 1,22,808 2 1,00,000 40,000 1,40,000 0.7695
1,07,730 3 80,000 40,000 1,20,000 0.6750 81,000 4 80,000 40,000
1,20,000 0.5921 71,052 5 40,000 40,000 80,000 0.5194 41,552
Present Value of Cash Inflow 4,24,142 Present Value of Cash
Outflow 2,00,000 Net Present Value 2,24,142 Net Present Value is
positive, hence XYZ & Co should invest in the project. Illustration 11
: Find out the present value of a debenture from the following : Face
value of debenture Rs. 1,000 Annual Interest Rate 15% Expected
return 12% Maturity Period 5 years (Present values of Re. 1 at 12%
are, 0.8929, 0.7972, 0.7118, 0.6355 and 0.5674) Solution PVd = 1
(PVAF) + F (DF) = 1(PVAF 12% for 5 years) + F (DF 12% for 5
years) = 150 (3,6048) + 1,000 (0.5674) = Rs. 540.72 + 567.40 = Rs.
1108.12 Illustration 12 : Mr. Vishwanathan is planning to buy a
machine which would generate cash flow as follows : Year 0 1 2 3 4
Cash Flow (25000) 6000 8000 15000 8000 29 If discount rate is 10%,
is it worth to invest in machine ? Year 1 2 3 4 Discount Factor 0.909
0.826 0.751 0.683 Solution : Calculation of Net Present Value Year
Cash Flow (Rs.) Discount Factor Present Value (Rs.) 1 6,000 0.909

5454 2 8,000 0.826 6608 3 15,000 0.751 11265 4 8,000 0.683 5464
Present value of cash inflow 28791 (-) Present Value of cash outflow
25000 Net Present Value 3791 As the NPV is positive, it is worth
investing in the machine. Illustration 13 : A machine cost Rs. 80,000
and is expected to produce the following cash flows : Year 1 2 3 4 5 6
7 Cash Flow (Rs) 50000 57000 35000 60000 40000 30000 60000 If
the cost of capital is 12 percent, is it worth buying the machine ? 30
Solution Calculation of Net Present Value Year Cash Inflow D.F. @
12% Present Value (Rs.) 1 50,000 0.8929 44645 2 57,000 0.7972
45440 3 35,000 0.7118 24913 4 60,000 0.6355 38130 5 40,000
0.5674 22696 6 30,000 0.5066 15198 7 60,000 0.4523 27138 Present
Value of Cash Inflow 218160 Present Value of outflow 280000 Net
Present Value -61840 As the Net Present Value is negative, it is not
worth buying the machine. Illustration 14 : Find the compounded
value of annuity where three equal yearly payments of Rs. 2000 are
deposited into an account that yields 7% compound interest. Solution
(1 + R)t – 1 The future value of annuity FVa = A R = Rs. 2,000
(FVAFA @ 7% for 3 years) = Rs. 2,000 x 3.215 = Rs. 6,430
Illustration 15 : Calculate the compound value when Rs. 10,000 are
invested for 3 years and the interest on it is compounded at 10%
p.asemi annually. FV = PV x CF FV = PV x (1 + R)t 10 = 10,000 X
(1 + 2 ) 2 x 3 = 10,000 (1.05) 6 = Rs. 10,000 x 1.340 = Rs. 13,400 31.

UNIT 2
Capital Structure: Introduction; capital structure decisions
INTRODUCTION
Capital structure is the mix of different securities to a firm’s
capitalisation. It is the permanent financing of the company
represented primarily by long-term debt and shareholder’s equity. It is
also a part of a company’s financial structure. The choice of capital
structure depends upon a number of factors such as nature of business,
regularity of earnings, conditions of the financial markets and
attitudes of the investors. A capital structure will be considered
appropriate if it possesses profitability, solvency, flexibility,
conservatism and control. The capital structure of a company is to be
determined initially at the time of incorporation of a company. The
initial capital structure will have long term implications. It may not be
possible to have optimum capitalstructure but the management should
set a target capital structure and the initial capital structure should be
framed keeping in view the target capital structure. Therefore, the
capital structure decision is a continuous one.
MEANING OF CAPITAL STRUCTURE: Capital structure is the
mix of a firm’s capitalisation. It includes long term sources of funds
such as debentures, shares, etc. According to Gavstenberg, capital
structure is the “make-up of a firm’s capitalisation.” Thus, it
represents the mix of different sources of long term funds, in the
capitalisation of the company. The term capitalisation is used with
reference to the total long term funds raised by a company.
The decisions regarding the form of financing, their requirements and
their relative proportions in the total capital of a company are known
as capital structure decisions. The company management has to take
extreme care and prudence in arriving at the proper capital structure.
The term capital structure is used for the mix of capitalisation. The
capitalisation is used for the sources of long-term capital of a
company. The long term sources of raising capital are issue of shares,
debentures or bonds and long-term borrowings. The share is a owned
capital and debentures and bonds are borrowed capital. Hence, there
should be a mix of sources of capital. The capital structure of a
company is to be determined initially, at the time of formation of the

company. The initial capital has long-term implication and hence
proper care should be taken while deciding the sources of capital at
the beginning. The capital structure should be flexible, profitable and
simple. The initial capital structure of a company depends upon many
factors. 6.3 CHOICE OF A CAPITAL STRUCTURE: The choice
of an appropriate capital structure depends upon a number of factors.
These factors include nature of company’s business, regularity of
earnings, conditions of financial markets, attitude of the management
as well as the investors. However, a firm has the choice to raise funds
for financing its projects with the following choices: (a) Only with
equity shares. (b) With equity and preference shares. (c) With equity
shares and debentures. (d) With equity shares, preference shares and
debentures.
A capital structure will be considered to be appropriate if it possesses
the following features:
(i) Flexibility: The capital structure should be determined in such a
way that there should be some scope for changes according to the
changing circumstances. It should be possible for the company to
provide funds whenever needed for financing its activities. (ii)
Profitability: The capital structure of a company should be most
profitable. The objective of a company is to maximise the return to
the shareholders. Therefore, the capital structure should tend to
minimise cost of financing and at the same time maximise the returns
to the shareholders. (iii) Solvency: The capital structure should be
determined in such a way that it should not be a risk of becoming
insolvent. Excessive use of debt or borrowed capital in the capital
structure results into insolvency. It affects profitability as well as
liquidity of the company adversely. (iv) Conservative: The capital
structure of a company should be conservative in the sense that the
debt portion in the capital structure should not exceed the limit which
the company can bear. Normally, the debt-equity ratio should not be
more than 2: 1. (v) Control: While deciding the capital structure of a
company, the management has to see that its control should not be
reduced. The promoter’s control should not be reduced. The
promoters control the company with more proportion of equity than

debt. In order to avoid this, a proper balance between owned capital
and debt capital should be maintained.
OPTIMUM CAPITAL STRUCTURE: Optimum capital structure is
that capital structure at which the value of equity share is the
maximum while the average cost of capital is the minimum. The value
of equity share mainly depends upon the earnings per share. The
theory of capital structure deals with the issue of the right mix of debt
and equity in the long-term capital of the company. If a company
raises debt, the value of equity shares goes up to a certain point. If the
debt increases beyond that point, the value of equity shares goes
down. Therefore, the company should determine its appropriate level
of debt-equitymix which is known as optimum capital structure.
IMPORTANCE OF CAPITAL STRUCTURE: The capital
structure decisions are very important in financial management. These
decisions influence debt-equity mix which ultimately affects
shareholders.’ return and risk. Since the cost of debt is cheaper,
companies prefer to borrow. The value of equity depends upon
earnings per share. As long as return on investment is more than the
cost of borrowings, extra borrowings will increase the earnings per
share. However, beyond the limit, it increases the risk and the share
price may fall. The effect of fall in share price due to heavy load of
debt is difficult to measure. Market factors are so highly
psychological and complex as they hardly follow these theoretical
considerations. However, a company can determine an appropriate
debt-equity mix empirically, considering various factors. The debt-
equity mix in the capital structure is one of the important factors.
Affecting the value of a share of a company. There is a significant
relationship between the share price and the variables like return, risk,
growth size and leverage. Companies in India are now showing
almost an equal preference for debt and equity in designing their
capital structure. This is due to the freedom in paying dividend and
easy to raise money. However, the returns have become uncertain due
to increasing competition. An important function of financial
management is to decide an appropriate capital structure of their
company. The financial performance of a company depends upon the
capital structure decisions. A good capital structure will help the

company to increase profits, efficiency and reputation of the
company. Therefore, capital structure decisions are very important.
FACTORS AFFECTING CAPITAL STRUCTURE: An
appropriate capital structure can be determined on the basis of the
following factors:
(1) TRADING ON EQUITY: Trading on equity means use of owned
capital as well as borrowed capital in the capital structure of a
company. A company can raise funds by issue of shares and
debentures. Debentures carry a fixed rate of interest and the interest is
paid irrespective of profits. A company can also raise capital only by
issue of shares. In this case, the shareholders will get less amount of
dividend because of large number of shareholders. However, if a
company issues shares as well as debentures, the shareholders will be
benefited more in the form of dividend. Debenture holders have a
limited share in the company’s profits and hence want to be protected
in terms of earnings and values represented by equity-capital. Fixed
interest on debt does not vary with the firms’ earnings before interest
and tax, a magnified effect is produced on earnings per share.
Illustration 1: A Ltd wants to raise Rs. 1, 00,000 as capital. The
company expects earnings before interest and taxes (EBIT) Rs.
40,000 per annum. The management is considering the following
alternatives for raising the capital: (a) Issue 10,000 equity shares of
Rs. 10 each. (b) Issue 5000 equity shares of Rs. 10 each and 500, 12%
preference shares of Rs. 100 each. (c) Issue 5000 equity shares of Rs.
10 each and 10 % Debentures of Rs. 50,000. You are required to
calculate earnings per share and advise the alternative to be used for
raising capital, assuming tax rate of 30%.
Solution: Calculation of earnings per share: Alternatives (a) Rs. (b)
Rs. (c) Rs. EBIT 40,000 40,000 40,000 Less: Interest – – 5,000 EBT
40,000 40,000 35,000 Less: Tax @ 30% 12,000 12,000 10,500 PAT
28,000 28,000 24,500 Pref. Dividend – 6,000 – Profit available to
equity shareholders 28,000 22,000 24,500 Number of equity shares
10,000 5,000 5,000 Earning per share Rs. 2.80 4.40 4.90 In case of
alternative (c) i.e. capital structure consisting of debt-equity (trading
on equity) the earnings per share is highest, hence the alternative (c)
should be followed in order to maximize the return to shareholders.

(2) LEVERAGES: Leverage is the ability of a firm to use fixed
costassets or funds to magnify the return to its owners. There are two
leverages associated with the capital structure i.e. operating leverage
and financial leverage. Operating leverage exists when a firm has
afixed cost that must be incurred regardless of volume of business. On
the other hand, financial leverage is a mix of debt and equity in the
capitalisation of the firm. In order to decide proper financial policy,
operating leverage may be taken into consideration as the financial
leverage is a superstructure built on the operating leverage. The
operating profits i.e. earnings before interest and taxes (EBIT) serves
as a function in defining these two leverages. Financial leverage
represents the relationship between the firms’ earnings before interest
and taxes and earnings available for equityholders. When there is an
increase in EBIT there is a corresponding increase in market price of
equity shares. However, increased use of debt in the capital structure
has certain limitations. If debt capital is employed in greater
proportion, marginal cost of debt will also increase and share price
may fall as investors may find it risky. On the other hand, in spite of
increased risk, market price of shares may increase due to speculation.
Therefore, before using financial leverage, its impact on Earning Per
Share (EPS) must be considered. A company having higher operating
leverage should use low financial leverage and vice versa otherwise, it
may face problems of insolvency and inadequate liquidity.
Illustration
GTL Ltd, a widely held company is considering a major expansion of
its production facilities and the following alternatives are available:
Alternatives (Rs. lakhs) A B C Share Capital (Rs. 10) 50 20 10 14%
Debentures – 20 15 Loan from financial Institution @15% – 10 25
Expected rate of return before tax is 25%. The rate of dividend of the
company is not less than 20%. The company at present has low debt.
Corporate tax is 30%. Which of the alternatives you would choose?
Solution: Evaluation of financial alternative (Rs. lakhs) Particulars A
B C Earnings before Int. & Taxes ( 25% of Rs. 50 lakhs) 12.50 12.50
12.50 Less: (i) Interest on Debentures – 2.80 2.10 (ii) Interest on Loan
– 1.50 3.75 EBT 12.50 8.20 6.65 Less: Taxes 3.75 2.46 2.00 PAT
8.75 5.74 4.65 Number of Shares (lakhs) 5.00 2.00 1.00 Earning per

Share 1.75 2.87 4.65 Alternative (C) is more profitable because
shareholders will be benefited more. Therefore alternative (C) should
be chosen.
(3) INTEREST COVERAGE RATIO: The ability of a firm to use
debt in the capital structure may be judged in terms of interest
coverage ratio. It is the ratio or relation between operating profit and
interest. Higher the ratio, greater is the certainty of meeting interest
payment. If the ratio is lower, the firm may not be able to pay interest
in future.
(4) CASH FLOW ANALYSIS: EBIT-EPS analysis is a good
supporting tool in determining a suitable capital structure. Cash flow
under adverse situation should be examined in order to determine the
debt capacity. A high debt-equity ratio may not be risky if the
company has the ability to generate adequate cash flows. It may be
possible to increase the debt until cash flows equal to the risk set out
by debt capital. With the help of information available, a range can be
determined for an optimum level of debt in the capital structure.
Illustration 3: BEST Ltd, a profit making company has paid up
capital of Rs. 100 lakhs consisting of 10 lakhs equity shares of Rs. 10
each. Currently it is earning an annual pre-tax profit of Rs. 60 lakhs.
The company’s shares are listed and quoted in the range of Rs. 50 to
Rs. 80. The management wants to diversity production and has
approved a project which will cost Rs. 50 lakhs and it is expected to
yield a pre-tax income of Rs. 40 lakhs per annum. To raise this
additional capital, the following options are under consideration of the
management.
(a) To issue equity capital for the entire additional amount. It is
expected that the new shares (face value Rs. 10) can be sold at a
premium of Rs. 15. (b) To issue 16% non-convertible debenture of
Rs. 100 each for the entire amount. (c) To issue equity capital for Rs.
25 lakhs (face value Rs. 10) and 16% non-convertible debenture for
the balance amount. In this case, the company can issue shares at a
premium of Rs. 40 each. You are required to advise the management
as to how the additional capital can be raised keeping in mind that the
management wants to maximise the earning per share to maintain its
goodwill. The tax rate applicable to the company is 30%.

Solution: Calculation of EPS under three options (Rs. in lakhs)
Particular I II III Equity Debt Debt + Equity Earning before Interest &
Tax: Current operations 60 60 60 New operations 40 40 40 Total 100
100 100 Less: Interest on Debt – 8 4 Profit before tax 100 92 96 Less:
Tax 30 27.6 28.8 Profit after tax 70 64.4 67.2 Number of Equity
Share: Existing (lakhs) 10 10 10 New Issued (lakhs) 2 – 0.50 12 10
10.50 ?Earning per Share 70 64.4 67.2 12 10 10.50 EPS (Rs.) 5.83
6.44 6.4 Option II, i.e. issue of 16% Debentures is most suitable to
maximize the EPS.
Illustration 4: ‘Z’ Ltd is currently EBIT of Rs. 12 lakhs. Its present
borrowings are: (Rs. in Lakhs) 12% Term Loans 40 Working Capital
– Bank Loan @ 15% 35 Public Deposit @ 12% 15 The sales of the
company are growing and to support this, the company proposes to
obtain an additional bank borrowing as Rs. 25 lakhs at 15% p.a. The
increase in EBIT is expected to be 20%. Calculate the change in
interest coverage ratio after additional borrowings and after your
comments. Solution: (i) The present EBIT is Rs. 12 lakhs (ii) Interest
on present borrowing Rs. Term Loans-12% of Rs. 40 lakhs = 4.80
lakhs Public Deposit- 12% of Rs. 15 = 1.80 lakhs Bank Loan- 15% of
Rs. 35 = 5.25 lakhs Total 11.85 lakhs (iii) Present Interest Coverage
Ratio = EBIT Interest = 12.00 11.85 = 1.01 Times. (iv) Revised
EBIT= 12 u 120 100 = Rs. 14.40 lakhs (v) Revised amount of
interest= Rs.11.85 lakhs u 15% of 25 lakhs = Rs. 11.85 + Rs. 3.75
lakhs = Rs. 15.6 lakhs (vi) Revised Interest Coverage Ratio = EBIT
Interest = 14.40 15.60 = 0.92. Illustration 5: Mangalore Chemicals
Ltd. requires Rs. 25 lakhs for a new plant. This plant is expected to
yield earnings before interest and taxes of Rs. 5 lakhs. While deciding
about the financial plan, the 124 company considers the objective of
maximising earnings per share. It has three alternatives to finance the
project by raising debt of Rs. 2,50,000 or Rs. 10,00,000 or Rs.
1,50,000 and the balance in each case, by issuing equity shares. The
company’s share is currently selling at Rs. 150 but it is expected to
decline to Rs. 125 in case the funds are borrowed in excess of Rs.
10,00,000. The funds can be borrowed at the rate of 10% up to Rs.
2,50,000 at 15% over Rs. 2,50,000 and up to Rs. 1,00,000 and at 18%

over Rs. 10,00,000. The tax rate applicable to the company is 30%.
Which form of financing should the company chose?
Evaluation of alternative proposals (Rs.) Plan / particular I
(2.50+22.50) II (10+15) III (15+10) EBIT 5,00,000 5,00,000 5,00,000
Less: Interest 25,000 1,50,000 2,70,000 EBT 4,75,000 3,50,000
2,30,000 Less: Tax 1,42,500 1,05,000 69,000 PAT 3,32,500 2,45,000
1,61,000 Number of Shares 15,000 10,000 8000 Earnings per Share
Rs. 22.17 24.50 20.125 Earning per share in case of alternative II is
highest. Hence,Earning per share in case of alternative II is highest.
Hence, the company should finance the new plant by raising Rs. 10
lakhs of Debt @ 15% and issue of equity shares. The company can
issue 10,000 Equity shares at Rs. 150 each and raise Rs. 15 lakhs
through equity.
CAPITAL STRUCTURE THEORIES: A firm has to maintain an
optimum capital structure with a view to maintain financial stability.
The optimum capital structure can be obtained when the marked value
per share is the maximum. Therefore, the objective of the firm should
be to select a financing or debt equity mix which will maximise the
value of the firm, optimum leverage can be the mix of debt-equity
which maximises the value of a company. In order to achieve this
goal, the finance manager has to follow the theories of capital
structure of corporate enterprises. There are four major theories which
explain the relationship between capital structure, cost of capital and
value of the firm. These are as follows:
(1) Net Income Approach. (2) Net Operating Income Approach.
(3) Modigliani- Miller Approach (MM). (4) Traditional
Approach.
However, in order to understand this relationship, the following
assumptions are made: (i) The firm employs only two types of capital
i.e. debt and equity capital. (ii) Taxes are not considered. (iii) The
firm pays its earnings in full as dividend. There is no returned earning.
(iv) The firm’s total assets are given and there is no change in the
assets. (v) The firm’s total financing remains constant. The firm can
change its capital structure by interchanging the source of finance.
(vi) The operating profit is not expected to change. (vii) The business
risk remains constant and it is independent of capital structure and

financial risk. (viii) The firm has a perpetual life. It means the
business is a going concern and it has long life. (ix) All the investors
has the same subjective probability distribution of the future expected
operating profits for a given firm.
(2) NET INCOME APPROACH (NI): David Durand, of USA,
had suggested this approach. According to him, capital structure
decision is relevant to the valuation of the firm. It means, a change in
the capital structure causes a corresponding change in the overall cost
of capital as well as the total of the firm. This approach also suggests
that a higher debt content in the capital structure will result in decline
in the overall cost of capital. This will cause increase in the value of
the firm and consequently increase in the value of equity shares of the
company. The Net Income Approach is based on the following
assumptions: (i) The cost of debt is less than cost of equity. (ii) The
debt content does not change the risk perception of theThus, the Net
Income Approach suggests that an increase in financial leverage will
lead to decline in the weighted average cost of capital and the value of
the firm as well as market price of equity shares will increase. On the
other hand, a decrease in the financial leverage will cause on increase
in the weighted average cost of capital and a consequent decline in the
value as well as market price of equity shares. The value of the firm
on the basis of Net Income Approach can be ascertained as follows: V
= S + D where, V = Value of the firm S = Market value of equity D =
Market value of Debt The market value of Equity can be ascertained
as follows: S = NI Ke where, S = Market value of Equity NI =
Earnings available to Equity shareholders. Ke = Equity capitalisation
rate Under Net Income approach, the value of the firm will be
maximum at a point where weighted average cost of capital is
minimum. Therefore, the theory suggests maximum possible
debtfinancing for minimizing the cost of capital. The overall cost
capitalis determined as follows:
(3) Overall cost of capital = EBIT Value of the firm Illustration 6:
The EBIT of Kripa Ltd is Rs. 5,00,000. The company has 10%
Debentures of Rs. 20,00,000. The equity capitalisation rate is 15%.
You are required to calculate: (i) Market value of Equity (ii) Value of
the Company (iii) Overall cost of capital.

Solution: Statement showing value of firm Net Income Approach Rs.
Earnings before interest & Taxes (EBIT) 5,00,000 Less: Interest on
Debenture ( 10% of 20,00,000) 2,00,000 Net Income 3,00,000 Equity
capitalisation rate = (Ke) = 15% (i) Market value of Equity = NI Ke =
3‚00‚000 15 u100 = Rs. 20,00,000 (ii) Value of the company = Value
of Equity + Value of Debt = Rs. 20,00,000 + 20,00,000 = Rs.
40,00,000 (iii) Overall cost of capital = EBIT Value of firm u 100 =
5‚00‚000 40‚00‚000 u 100 = 12.5% Illustration 7: Zed Ltd is
expecting on annual EBIT of Rs. 10,00,000. The company has Rs. 40
lakhs in 10% Debentues. The cost of equity capital or capitalisation
rate is 12.5%. You are required to calculate the total value of the
company and overall cost of capital. Solution: Statement showing
value of the firm Net Income Approach Rs. Earnings Before interest
& Taxes 10,00,000 Less: Interest (10% of 40,00,000) 4,00,000 Net
Income 6,00,000.
Equity capitalisation rate = 12.5%
a) Market Value of Equity (s) = NI Ke = 6‚00‚000 12.5% = Rs.
48,00,000 (b) Market Value of Debt is Rs. 40,00,000 (c) Value of the
firms = S+D = Rs. 48,00,000 + Rs. 40,00,000 = Rs. 88,00,000 (d)
Overall Cost of capital = EBIT Value of firm u 100 = 10‚00‚000
88‚00‚000 u 100 = 11.36% Illustration 8: ‘H’ Ltd is expecting annual
EBIT of Rs. 10,00,000. The company has issued 10% Debentures of
Rs. 40,00,000. The equity capitalisation rate is 12.5%. The company
desires to redeem debentures of Rs. 10,00,000 by issuing additional
equity shares of Rs. 10,00,000. You are required to calculate the value
of the firm and also the overall cost of capital. Solution: Statement
showing the value of the firm Net Income Approach Rs. EBIT
10,00,000 Less: Interest ( 10% of 30,00,000) 3,00,000 Net Income
7,00,000 Equity capitalisation Rate = Ke = 12.5% (a) Market value of
Equity (S) = NI Ke = 7‚00‚000 12.5% = Rs. 56,00,000 (b) Market
value of the firm = S + D = Rs. 56,00,000 + 30,00,000 = Rs.
86,00,000.
b) Overall cost of capital = EBIT Valuation of firm u 100 =
10‚00‚000 86‚00‚000 u 100 = 11.63% Illustration 9: The operating
income of ‘A’ Ltd is Rs. 6,00,000. The firms cost of debt is 10%. The
amount of Debt is Rs. 15,00,000. The overall cost of capital of the

firm is 15%. You are required to determine: (a) Total value of the firm
(b) Cost of equity Solution: (a) Statement sharing the value of the
firm: Earnings before Interest Taxes Rs. 6,00,000 Less: Interest on
Debentures 10% of Rs. 15,00,000 1,50,000 Net Income 4,50,000
Total cost of capital 15% ? Value of the firm = EBIT Ke = 6‚00‚000
0.15 = Rs. 40,00,000 ?Market value of Equity = V – D = Rs.
40,00,000 – 15,00,000 = Rs. 25,00,000 (b) Calculation of cost of
Equity Cost of equity (Ke) = Net Income Market Value of Equity u
100 = 4‚50‚000 25‚00‚000 u100 = 18% 6.7.2 NET OPERATING
INCOME APPROACH (NOI): This approach was also suggested by
Mr. David Durand.
Net operating Income means earning before interest and tax. This
approach suggests that the market value of the firm is not at all 130
affected by the capital structure changes. The capital structure
decisions of the firm are irrelevant. And change in the leverage will
not lead to any change in the total value of the firm and the market
price of the shares. The market value of the firm is ascertained by
capitalising the net operating income at the overall cost of capital (K)
which is considered to be constant. The market value of equity is
ascertained by deducting the market value of the debt from the market
value of the firm.
The net operating income approach is based on the following
assumptions: (1) The overall cost of capital (K) remains constant for
all degree of debt-equity mix. (2) The market capitalises the value of
the firm as a whole and therefore, the spit between debt and equity is
not relevant. (3) The low cost debt increases the risk of equity
shareholders. This results in increase in equity capitalisation rate. An
increase in the use of debt is offset by an increase in the equity
capitalisation rate. The value of the firm is determined as follows: V =
EBIT k Where, V = Value of the firm K = Overall cost of Capital
EBIT = Earning before interest and tax. The value of equity can be
determined by using the following formula: S = V – D Where, S =
Value of Equity V = Value of firm D = Value of Debt Illustration 10:
‘X’ Ltd has an EBIT of Rs. 10 lakhs. The cost of Debt is 10% and the
outstanding debt amounts to Rs. 3,00,000. If the overall capitalisation
rate is 12.5%, calculate the total value of the firm and equity

capitalisation rate. 131 Solution: (a) Statement showing the value of
the firm (Net Operating Income Approach) Rs. EBIT 10,00,000
Overall capitalisation rate = 12.5% ? Market Value of the firm= EBIT
K = 10‚00‚000 12.5% Value of Debt 80,00,000 ? Value of Equity
30,00,000 50,00,000 Equity Capitalisation Rate = Ke = EBIT – I V –
D u 100 = 10‚00‚000 – 3‚00‚000 80‚00‚000 – 30‚00‚000 u 100 =
7‚00‚000 50‚00‚000 u 100 = 14% Illustration 11: ‘Y’ Ltd has an EBIT
of Rs. 30,00,000. Its cost of debt is 12.5% and the outstanding debt is
Rs. 40,00,000. The overall capitalisation rate is 15%. The company
decides to raise a sum of Rs. 10,00,000 through issue of equity shares
and use the proceeds to redeem the debt. You are required to calculate
the total value of the firm and equity capitalisation rate. Solution: (a)
Statement showing the value of the firm (Rs.) EBIT 30,00,000
Overall capitalisation Rate = 15% ? Market Value of the firm =
30‚00‚000 15% 2,00,00,000 Value of Debt 30,00,000 ? Market Value
of Equity 1,70,00,000 132 (b) Equity Capitalisation Rate = EBIT – I
V – D u100 = 30‚00‚000 – 3‚75‚000 2‚00‚00‚000 – 30‚00‚000 u 100
= 26‚25‚000 1‚70‚00‚000 u 100 = 15.44%
MODIGILIANI-MILLER APPROACH (MM): Modigiliani–
Miller approach provides behavioural justification for constant overall
cost of capital and total value of the firm. It does not provide
operational justification for irrelevance of the capital structure in the
valuation of the firm. According to this approach the value of a firm is
independent of its capital structure. MM approach maintains that the
average cost of capital does not change with change in the debt-
weighted equity mix or capital structure of the firm.
The three basic propositions of the MM approach are as follows: (1)
The overall cost of capital (K) and the value of the firm (V) are
independent of the capital structure. In other words ‘K’ and ‘V’ are
constant for all levels of debt–equity mix. The total market value of
the firm is given by capitalising the expected net operating income
(NOI) by the rateappropriate for that risk class. (2) The cost of equity
(Ke) is equal to capitalisation rate of a pure equity stream plus a
premium for the financial risk. The financial risk increases with more
debt content in the capital structure. Thus, (Ke) increases in a manner
to offset exactly the use of a less expensive source of funds

represented by debt. (3) The cut-off rate of investment purposes is
completely independent of the way in which an investment is
financed. MM approach is based on the following assumptions: (1)
Capital markets are perfect. This means investors are rational and are
well informed. (2) All the firms within the same risk class will have
the same degree of business risk. (3) All investors have the same
expectation of a firm’s netoperating income with which to evaluate
the value of any firm.
According to MM approach the total investment value of a firm
depends upon its underlying profitability and risk. The operational
justification of MM approach can be explained through the
functioning of the arbitrage process. Arbitrage refers to buying asset
or security at lower price in one market and selling it at a higher price
in another market. As a result equilibrium is attained in different
markets. For example, there are two identical firms. One has debt in
its capital structure and other is not having the debt. Investor of the
firm whose value is higher will sell their shares and buy the shares of
the firm whose value is lower. They will be able to earn the same
return at lower outlay with the same perceived risk or lower risk.
They would, therefore, be better off. The value of the leveraged firm
can neither be greater nor lower than that of an unleaveraged firm.
Thus, there is neither advantage nor disadvantage in using debt in the
firm’s capital structure. Illustration 12: Two firms A and B are
identical in all respect except the firm A has 10% Debentures of Rs. 5,
00,000. Both the firms have the same earnings before interest and tax
accounting to Rs. 1, 00,000. The equity capitalisation rate of firm A is
16% and that of B is 12.5%. You are required to calculate the total
market value of each of the firms. Solution: Statement showing the
total value of the firms Particulars A (Rs.) B (Rs.) Earnings before
Interest + Taxes 1,00,000 1,00,000 Less: Interest 50,000 – Earning
available to Equity Shareholders 50,000 1,00,000 Equity
Capitalisation Rate 16% 12.5% ?Total Market value of Equity
3,12,500 8,00,000 © ¨ § ¹ ¸ 50‚000· 16% , © ¨ § ¹ ¸ 1‚00‚000· 12.5%
Total value of firms: Equity + Debt 8,12,500 8,00,000 Overall cost of
capital 1‚00‚000 8‚12‚500 u100 1‚00‚000 8‚00‚000 u100 = 12.30%
12.5% 134 Illustration 13: The two companies X Ltd and Y Ltd are

having same earnings before interest and taxes of Rs. 2,00,000. Y Ltd
is levered company having a debt of Rs. 10,00,000 @ 9% rate of
interest. The cost of equity of X Ltd is 10% and that of Y Ltd is
11.50%. You are required to calculate the total value of each
company. Solution: Statement sharing the total value of firms
Particulars X (Rs.) Y (Rs.) Earnings before Interest & Taxes 2,00,000
2,00,000 Less: Interest – 90,000 Earning available to Equity
shareholders 2,00,000 1,10,000 Equity capitalisation Rate 10%
11.50% ? Market value of Equity 20,00,000 9,56,522 Market value of
Debt – 10,00,000 Total market value 20,00,000 19,56,522 Overall
cost of capital 2‚00‚000 20‚00‚000 u100 2‚00‚000 19‚56‚522 u100 =
10% = 10.22%
TRADITIONAL APPROACH: Traditional approach favors that as
a result of financial leverage up to a certain level cost of capital comes
down and value of the firm increases. However, beyond that level
reserve trend emerges. Thus, the essence of the traditional approach
lies in the fact that a firm through judicious use of debt-equity mix
can increase its total value and thereby reduce its overall cost of
capital. It is because debt is a cheaper source of funds as compared to
raising money through shares because of tax advantage. However,
raising debt beyond a certain point may become a financial risk and
would result in higher equity capitalisation rate. The principal
implication of traditional approach is that the cost of capital is
independent on the capital structure and there is an optimal capital
structure which minimises cost of capital. At the optimal capital
structure the real marginal cost of debt and equity is the same. Before
the optimal point the real marginal cost of debt isless than real
marginal cost of debt is more than the real marginal cost of equity and
beyond this point the real marginal cost of debt is more than the real
marginal cost equity. Therefore, the firm should strive to reach the
optimal capital structure and its total valuation through a judicious use
of the debt and equity capital in the capital structure. At the optimal
capital structure the overall cost of capital will be minimum and the
value of the firm is maximum.
Capital Budgeting is the art of finding assets that are worthmore than
they cost to achieve a predetermined goal i.e.,‘optimizing the wealth

of a business enterprise’.Capital investment involves a cash outflow
in the immediatefuture in anticipation of returns at a future date.A
capital investment decision involves a largely irreversiblecommitment
of resources that is generally subject to significantdegree of risk. Such
decisions have for reading efforts on anenterprise’s profitability and
flexibility over the long-term.Acceptance of non-viable proposals acts
as a drag on theresources of an enterprise and may eventually lead to
bankruptcy.
For making a rational decision regarding the capital investment
proposals, the decision maker needs some techniquesto convert the
cash outflows and cash inflows of a project intomeaningful yardsticks
that can measure the economic worthinessof projects.
CAPITAL BUDGETING PROCESS:
A Capital Budgeting decision involves the following process:
(1) Investment screening and selection
(2) The Capital Budget proposal
(3) Budgeting Approval and Authorization
(4) Project Tracking
(5) Post-completion Auditor
TIME VALUE OF MONEY :
We know that Rs. 100 in hand today is more valuable thanRs. 100
receivable after a year. We will not part with Rs. 100 now ifthe same
sum is repaid after a year. But we might part with Rs. 100now if we
are assured that Rs. 110 will be paid at the end of thefirst year. This
“additional Compensation” required for parting Rs.100 today, is
called “interest” or “the time value of money”. It isexpressed in terms
of percentage per annum.
Why should money have time value?
Money should have time value for the following reasons:
(a) Money can be employed productively to generate real returns;
(b) In an inflationary period, a rupee today has higher
purchasingpower than a rupee in the future;
(c) Due to uncertainties in the future, current consumption ispreferred
to future consumption.
(d) The three determinants combined together can be
expressedNominal or market interest rate

= Real rate of interest or return (+) Expected rate of inflation (+)
Risk premiums to compensate for uncertainty.
METHODS OF TIME VALUE OF MONEY
(1) Compounding: We find the Future Values (FV) of all the
cashflows at the end of the time period at a given rate of interest.
(2) Discounting : We determine the Time Value of Money at
Time“O” by comparing the initial outflow with the sum of the
PresentValues (PV) of the future inflows at a given rate of interest.
Time Value of Money
Compounding Discounting
(Future Value) (Present Value)
(a) Single Flow (a) Single Flow
(b) Multiple Flows (b) Uneven Multiple Flows
(c) Annuity (c) Annuity
(d) Perpetuity
FUTURE VALUE OF A SINGLE FLOW
It is the process to determine the future value of a lump sumamount
invested at one point of time.
n
FV PV 1 i n
Where,
FVn = Future value of initial cash outflow after n years
PV = Initial cash outflow
i = Rate of Interest p.a.n = Life of the Investment
and (1+i)n
= Future Value of Interest Factor (FVIF)
Illustration: 1
The fixed deposit scheme of Punjab National Bank offers
thefollowing interest rates:
Period of Deposit Rate Per Annum46 days to 179 days 5.0 ,180 days
< 1 year 5.51 year and above 6.0 ,180An amount of Rs. 15,000
invested today for 3 years will becompounded to:
n
n
3
FV PV 1 i

PV FVIF 6,3
PV 1.06
15,000 1.191
Rs. 17,865
Doubling Period “How long will it take for the amount invested tobe
doubled for a given rate of interest”?
(i) By Applying “Rule of 72”
72 DoublingPeriod
Rate of Interest
CAPITAL RATIONING
Capital rationing is a situation where a constraint or budget ceiling is
placed on the total size of capital expenditures during a particular
period. Often firms draw up their capital budget under the assumption
that the availability of financial resources is limited.
Under this situation, a decision maker is compelled to reject some of
the viable projects having positive net present value because of
shortage of funds. It is known as a situation involving capital
rationing.
FACTORS LEADING TO CAPITAL RATIONING
Two different types of capital rationing situation can be identified,
distinguished by the source of the capital expenditure constraint.
I. External Factors - Capital rationing may arise due to external
factors like imperfections of capital market or deficiencies in market
information which might have for the availability of capital.
Generally, either the capital market itself or the Government will not
supply unlimited amounts of investment capital to a company, even
though the company has identified investment opportunities which
would be able to produce the required return. Because of these
imperfections the firm may not get necessary amount of capital funds
to carry out all the profitable projects.
II. Internal Factors - Capital rationing is also caused by internal
factors which are as follows:
Reluctance to take resort to financing by external equities in order to
avoid assumption of further risk. Reluctance to broaden the equity
share base for fear of losing control. Reluctance to accept some viable

projects because of its inability to manage the firm in the scale of
operation resulting from inclusion of all the viable projects.
SITUATIONS OF CAPITAL RATIONING
Situation I - Projects are divisible and constraint is a single period
one:
The following are the steps to be adopted for solving the problem
under this situation: a. Calculate the profitability index of each project
b. Rank the projects on the basis of the profitability index calculated
in (a) above. c. Choose the optimal combination of the projects.
Situation II - Projects are indivisible and constraint is a single period
one
The following steps to be followed for solving the problem under this
situation:
a. Construct a table showing the feasible combinations of the project
(whose aggregate of initial outlay does not exceed the fund available
for investment.
b. Choose the combination whose aggregate NPV is maximum and
consider it as the optimal project mix.
In a capital rationing situation (investment limit Rs. 25 lakhs), suggest
the most desirable feasible combination on the basis of the following
data (indicate justification) : (Rs. lakhs) Year Net cash flow NPV A
BCD 15 10 7.5 6
6 4.5 3.6 3
Project B and C are mutually exclusive.
Solution : Determination of feasible combination in Capital
Rotationing Situation (Investment Limit Rs. 25 lakhs) (
(Rs. lakhs) Combination Total outlay NPV
A&B A&C A&D B&D
C&D 25.00 22.50 21.00
16.00 13.50 10.50 9.60 9.00
7.50 6.60
Analysis : From the above analysis it is observed that projects A&B
combination give highest NPV of Rs. 10.50 lakhs. Therefore by
undertaking projects A and D, the wealth maximation is possible.
Illustration 2 : The total available budget for a company is Rs. 20
crores and the total cost of the projects is Rs. 25 crores. The projects

listed below have been ranked in order of profitability. There is
possibility of submitting X project where cost is assumed to be Rs. 12
crores and it has the Profitability Index of 140.
Project Cost (Rs. crores) Profitability index (P.V. of cash inflow/PV
of cash outflows) x 100 A B C D
E 6 5 7 2 5
150 125 120
115 110 25
Which projects, including X, should be acquired by the company?

Solution :
N.P.V of Projects
Project Cost PI P.V. of cash inflow NPV (1) (2) (3) (2) x (3) = (4) (4)
- (2) = (5) A B C D E X 6
5 7 2 5 13 1.5 1.25 1.20 1.15 1.10 1.40
9.00 6.25 8.40 2.30 5.50 18.20 3.00
1.25 1.40 0.30 0.50 5.20
Selection of project based on NPV, subject to the availability of total
funds Rs. 20 crores.
Project NPV Project cost X
A 5.20 3.00 13 6
8.20 19
The company will maximize its NPV by undertaking X and A, which
require total funds of Rs.19 crores. This option is suggested even
though there is no full utilisation of total funds. The surplus funds of
Rs. 1 crore can be deployed elsewhere profitably.
The following combination of projects will not maximise NPV
The following combination of projects will not maximise NPV :
Project (i) X B
NPV 5.20 1.25
Project cost 13 5 6.45
18 (ii) X C 5.20 1.40 13
7 6.60 20 (iii) X B D 5.20
1.25 0.30 13 5 2
6.75 20

Illustration A company is considering a cost saving project. This
involves purchasing a machine costing Rs. 7,000 which result in
annual savings on wage costs of Rs. 1,000 and on material costs of
Rs. 400.
The following forecasts are made of the rates of inflation each year
for the next 5 years :
Wages costs 10% Material costs 5% General prices 6%
The cost of capital of the company, in monetary terms, is 15%.

Evaluate the project, assuming that the machine has a life of 5 years
and no scrap value.
Solution:
Calculation of Net Present Value
Year Labour Cost Saving Material Cost Saving Total Savings
DCF @ 15%
Present Value
1 1000 X (1.1) = 1,100 400 X (1.05) = 420 1,520 0.870 1,322
2 1000 X (1.1)2 = 1,210 400 X (1.05)2 = 441 1,651 0.756 1,248
3 1000 X (1.1) 3= 1,331 400 X (1.05) 3= 463 1,794 0.658 1,180
4 1000 X (1.1)4 = 1,464 400 X (1.05) 4= 486 1,950 0.572 1,115
5 1000 X (1.1) 5= 1,610 400 X (1.05) 5= 510 2,120 0.497 1,054
Present Value of Total Savings 5,919
Less: Initial Cash Outflow 7,000
Net Present Value (Negative) (1,081)
Analysis: Since the present value of cost of project exceeds the
present value of savings it is not suggested to purchase the machine.
Illustration 8: D Limited, has under review a project involving the
outlay of Rs. 55,000 and expected to yield the following net cash
savings in current terms:
Year
1 2 3 4 Rs. 10,000 20,000 30,000 5,000
The company’s cost of capital, incorporating a requirement for growth

in dividends to keep pace with cost inflation is 20%, and this is used

for the purpose of investment appraisal. On the above basis the
divisional manager involved has recommended rejection of the
proposal.
Having regard to your own forecast that the rate of inflation is likely
to be 15% in year 1 and 10%, in each of the following years, you are
asked to comment fully on his recommendation. (Discounting figures
at 20% are 0.833, 0.694, 0.579 and 0.482 respectively for year 1 to
year 4.)
Solution : Calculation of Net Present Value
Year Cash Inflows
Discount Factor (20%)
Present Value
1 10,000 0.833 8,330
2 20,000 0.694 13,880
3 30,000 0.579 17,370
4 5,000 0.482 2,410
P.V. of cash inflows 41,990
Less: Initial Investment 55,000
Net Present Value (13,010)
Analysis: Since NPV is negative it is suggested not to take up the project.
Company’s cost of capital is fixed at 20% keeping in view the requirement
for growth in dividend as well as cost inflation.
Calculation: Net Present Value based on Inflation Adjusted Cash Flow
(Rs.)
Year Cash Flow Inflation Adjustment
Inflation AdjustmentDCF @ 20%
Present Value of Cash Flow
1 10,000 1.15 11,500 0.833 9,580
2 20,000 1.15X1.10 25,300 0.694 17,558
3 30,000 1.15X1.102 41,745 0.579 24,170
4 5,000 1.15X1.103 7,653 0.482 3,689
Present Value of Inflation Adjusted cash Inflows 54,997
Less: Initial Investment 55,000
Net Present Value (-) 3
Analysis :
The negative NPV is due to rounding of, otherwise it would be zero.
Hence, it is indifferent to suggest or reject the proposal.

UNIT 3
DIVIDEND POLICY
The main consideration in determining the dividend policy is the
objective of maximization of wealth of shareholders. Thus, a firm
should retain earnings if it has profitable opportunities, giving a
higher rate of return than cost of retained earnings, otherwise it should
pay them as dividends. It implies that a firm should treat retained
earnings as the active decision variable, and dividends as the passive
residual.
In actual practice, however, we find that most firms determine
the amount of dividends first, as an active decision variable, and the
residue constitutes the retained earnings. In fact, there is no choice
with the companies between paying dividends and not paying
dividends. Most of the companies believe that by following a stable
dividend policy with a high pay out ratio, they can maximize the
market value of shares. Moreover, the image of such companies also
improved on the market and the investors also favour such companies.
The firms following this policy, can thus successfully approach the
market for raising additional funds for future expansion and growth,
as and when required. It has therefore, been rightly said that
theoretically retained earnings should be treated as the active decision
variable and dividends as passive residual but practice does not
conform to this in most cases.
Illustration 1: ABC Ltd. belongs to a risk class for which the
appropriate capitalization rate is 10%. It currently has outstanding
5,000 shares selling at Rs.100 each. The firm is contemplating the
declaration of dividend of Rs.6 per share at the end of the current
financial year. The company expects to have net income of Rs.50,000
and has a proposal for making new investments of Rs.1,00,000. Show
that under the MM hypothesis, the payment of dividend does not
affect the value of the firm.
Solution:
A. Value of the firm when dividends are paid:
(i) Price of the share at the end of the current financial year.
P1 = P0 (1 + Ke) – D1

= 100 (1 + 10) – 6
= 100 x 1.10 – 6
= 110 – 6 = Rs.104
B. Value of the firm when dividends are not paid:

(i) Price per share at the end of the current financial year
P1 = P0 (1 + ke) – D1
= 100 (1+.10)-0
= 100´1.10
= Rs. 110
Hence, whether dividends are paid or not, the value of the firm
remains the same Rs. 5,00,000.
Illustration 2: Expandent Ltd. had 50,000 equity shares of Rs. 10
each outstanding on January 1. The shares are currently being quoted
at par the market. In the wake of the removal of dividend restraint, the
company now intends to pay a dividend of Rs. 2 per share for the
current calendar year. It belongs to a risk-class whose appropriate
capitalization rate is 15%. Using MM model and assuming no taxes,
ascertain the price of the company's share as it is likely to prevail at
the end of the year (i) when dividend is declared, and (ii) when no
dividend is declared. Also find out the number of new equity shares
that the company must issue to meet its investment needs of Rs. 2
lakhs, assuming a net income of Rs. 1.1 lakhs and also assuming that
the dividend is paid
Solution:
(i) Price as per share when dividends are paid
P1 = P0 (1+ke) – D1
= 10 (1+.15)-2
= 11.5-2
= Rs. 9.5.
(ii) Price per share when
not paid:
P1 = P0 (1+ke)-D1
= 10 (1+. 15)-0
= Rs. 11.5

Illustration 3: The following information is available in respect of a
firm:
Capitalisation rate = 10%
Earnings per share = Rs. 50
Assumed rate of return on investments:
(i) 12%
(ii) 8%
(iii) 10%
Show the effect of dividend policy on market price of shares applying
Walter's formula when dividend pay out ratio is (a) 0% (b) 20%, (c)
40%, (d) 80%, and (e) 100%
Solution :
Conclusion: From the above analysis we can draw the conclusion
that when,
(i) r>k, the company should retain the profits, i.e., when
r=12%. ke=10%;
(ii) r is 8%, i.e., r<k, the pay-out should be high; and
(iii) r is 10%; i.e., r=k; the dividend pay-out does not affect
the price of the share.
Illustration 4: The earnings per share of company are Rs. 8
and the rate of capitalisation applicable to the company is 10%. The
company has before it an option of adopting a payout ratio of 25% or
50% or 75%. Using Walter's formula of dividend payout, compute the
market value of the company's share if the productivity of retained
earnings is (i) 15% (ii) 10% and (iii) 5%
Solution:
Illustration 5: The earnings per share of a share of the face
value of Rs.100 to PQR Ltd. is Rs.20. It has a rate of return of
25%. Capitalisation rate of its risk class is 12.5%. If Walter's model
is used:
a) What should be the optimum payout ratio?
b) What should be the market price per share if the payout ratio is
zero?
c) Suppose, the company has a payout of 25% of EPS, what would
be the price per share?

Illustration 6: Determine the market value of equity shares of the
company from the following information:
Earnings of the company Rs.5,00,000
Dividend paid 3,00,000
Number of shares outstanding 1,00,000
Price-earning ratio 8
Rate of return on investment 15%
Illustration 7: The earnings per share (EPS) of a company is
Rs.10. It has an internal rate of return of 15% and the capitalization
rate of its risk class is 12.5%. If Walter's Model is used –
(i) What should be the optimum payout ratio of the company?
(ii) What would be the price of the share at this payout?
(iii) How shall the price of the share be affected, if a different
payout were employed?
Illustration 8 : From the following information supplied to you,
ascertain whether the firm is following an optimal dividend policy as
per Walter's model?
Total Earnings Rs.2,00,000
Number of equity shares (of Rs.100 each) 20,000
Dividend paid 1,50,000
Price/Earning ratio 12.5
The firm is expected to maintain its rate of return on fresh
investment. Also find out what should be the P/E ratio at which the
dividend policy will have no effect on the value of the share
Illustration 9: A company has total investment of Rs.5,00,000 assets
and 50,000 outstanding equity shares of Rs.10 each. It earns a rate of
15% on its investments, and has a policy of retaining 50% of the
earnings. If the appropriate discount rate for the firm is 10%,
determine the price of its share using Gordon Model. What shall
happen to the price, if the company has a payout of 80% or 20%.
INVESTMENT APPRAISAL TECHNIQUES
Pay back of capital Employed
Accounting Profit for project Evaluation
Time value of Money
Pay back Period Method NPV (a) Accounting Rate of Return (APR)
(b) Earnings per share (EPS)

(a) Net Present Value (NPV)
(b) Internal Rate of Return (IRR)
(c) Net Terminal Value (d) Profitability Index
(e) Discounted payback period
PAYBACK PERIOD METHOD
The basic element of this method is to calculate the recovery time, by
year wise accumulation of cash inflows (inclusive of depreciation)
until the cash inflows equal the amount of the original investment.
The time taken to recover such original investment is the “payback
period” for the project. “The shorter the payback period, the more
desirable a project”.
MERITS:
(1) No assumptions about future interest rates.
(2) In case of uncertainty in future, this method is most appropriate.
(3) A company is compelled to invest in projects with shortest
payback period, if capital is a constraint. (4) It is an indication for the
prospective investors specifying the payback period of their
investments. (5) Ranking projects as per their payback period may be
useful to firms undergoing liquidity constraints.
DEMERITS:
(1) Cash generation beyond payback period is ignored.
(2) The timing of returns and the cost of capital is not considered.
(3) The traditional payback method does not consider the salvage
value of an investment.
(4) Percentage Return on the capital invested is not measured.
(5) Projects with long payback periods are characteristically those
involved in long-term planning, which are ignored in this approach.
SOLVED PROBLEMS
Illustration 6:
Initial Investment = Rs. 1, 00,000 Expected future cash inflows Rs.
20,000, Rs.40,000, Rs. 60,000, Rs. 70,000
Solution:
Calculation of Pay Back period.
Year Cash Inflows (Rs.) Cumulative Cash Inflows (Rs.)
1 20,000 20,000 2 40,000 60,000 3 60,000 1,20,000 4 70,000
1,90,000

The initial investment is recovered between the 2nd and the 3rd year.
Payback Period =
Balance of Unrecovered Initial Investment 2years 12 Cash Inflows
during the year
Initial Investment – Cumulative = nd 2 years 12 rd Cash Inflows
in the3 year CashInflowsat theendof year =
1,00,000 2 years 12 60,000
40,000 2 years 12 60,000
= 2 years 8 months.
Illustration 7: Victory Ltd. decided to purchase a machine to increase
the installed capacity. The company has four machines under
consideration. The relevant details including estimated yearly
expenditure and sales are given below. All sales are for cash.
Corporate Tax Rate @ 33.99% (inclusive of Surcharge @ 10%,
Deduction cess @ 2% and Secondary & Higher Education cess @
1%)
Particulars M1 M 2 M 3 M4 Initial Investment (Rs. lacs) 30.00 30.00
40.00 35.00
Estimated Annual Sales (Rs. lacs) 50.00 40.00 45.00 48.00
Cost of Production (Estd) (Rs. lacs) 18.00 14.00 16.70 21.00
Economic Life (yrs) 2 3 3 4
Scrap Values (Rs. lacs) 4.00 2.50 3.00 5.00
Calculate Payback Period
Solution:
Statement Showing Payback for four machines
Particulars M1 M2 M3 M4
(1) Initial Investment (Rs. lacs) 30.00 30.00 40.00 35.00 (2) Estd.
Annual Sales (Rs. Lacs) 50.00 40.00 45.00 48.00 (3) Estd. Cost of
Production (Rs. lacs) 18.00 14.00 16.70 21.00 (4) Depreciation (Rs.
lacs) 13.00 9.17 12.33 7.50 (5) Profit Before Tax (PBT) [2–3–4]
19.00 16.83 15.97 19.50 (6) Tax @ 33.99% (Rs. lacs) 6.4581 5.721
5.428 6.628 (7) Profit After Tax (PAT) [5–6] (Rs. lacs) 12.5419
11.109 10.542 12.872 (8) Net Cash Flow [7+4] 25.5419 20.279
22.872 20.372
M 1 M2 M3 M4 Pay back Period (Years) = 30.00 = 30.00 =
40.00 = 35.00 25.5419 20.279 22.872 20.372

Initial Investment = 1.17 = 1.48 = 1.75 = 1.72 Net Annual
Cash Flow
Analysis: Machine 1 is more profitable, as it has the lowest payback
period.
Bailout Factor
This deals with the possibility of scrapping the machine during its
estimated life.
Illustration 8:
Project × costs Rs. 20 lacs and project y costs Rs. 30 lacs both have a
life of 5 years. Expected cash flows Rs. 8 lacs p.a. for project × and
Rs. 15 lacs p.a. for project y. Estimated scrap values of project × Rs. 5
lacs, declining at an annual rate of Rs. 1 lacs p.a. and of project y Rs.
8 lacs declining at an annual rate of Rs. 1 lac p.a.
Under Traditional payback:
Project X = 20,00,000 = 2.5Years
8,00,000
Project Y = 30,00,000 = 2 years 15,00,000
Under Bailout Payback: The bailout payback time is reached if the
accumulated cash inflows plus the expected salvage value at the end
of a particular year equals the original/initial investment.
Project X Cumulative Cash Receipts (Rs.)
Salvage Value (Rs.)
End of year 1: 8,00,000 5,00,000 = 13,00,000 End of year 2:
16,00,000 4,00,000 = 20,00,000
Bailout payback period for Project X = 2 years.
Project Y Cumulative Cash Receipts (Rs.)
Salvage Value (Rs.) End of year 1 :15,00,000 8,00,000 = 23,00,000
End of year 2 :30,00,000 7,00,000 = 37,00,000
Bailout is between years 1 & years 2.
Project Y is choosen having a lower bailout payback period, assuming
that the major objective is to avoid loss.
PAYBACK PERIOD RECIPROCAL
Payback period may be expressed alternatively as the “payback
reciprocal”:
Payback period reciprocal = 1 X 100 Payback period

Illustration 9: If the payback period for a project is 5 years, then the
payback period reciprocal would be:
1 X 100 = 20% 5
The projects having lower payback period shall yield higher payback
reciprocal, which reflects the worth of such project.
AVERAGE RATE OF RETURN
This method measures the increase in profit expected to result from
investment.
ARR = Average Annual Profit After Tax X 100 Average or Initial
Investment
= Average EBIT (1 - t) X 100 Average Investment
Where, Average Investment= Initial Investment + Salvage Value
MERITS
(1) This method considers all the years in the life of the project. (2) It
is based upon profits and not concerned with cash flows. (3) Quick
decision can be taken when a number of capital investment proposals
are being considered.
DEMERITS
(1) Time Value of Money is not considered.
(2) It is biased against short-term projects.
(3) The ARR is not an indicator of acceptance or rejection, unless the
rates are compared with the arbitrary management target.
(4) It fails to measure the rate of return on a project even if there are
uniform cash flows.
SOLVED PROBLEMS
Illustration 10:
A project costing Rs. 10 lacs. EBITD (Earnings before Depreciation,
Interest and Taxes) during the first five years is expected to be Rs.
2,50,000; Rs. 3,00,000; Rs. 3,50,000; Rs. 4,00,000 and Rs. 5,00,000.
Assume 33.99% tax and 30% depreciation on WDV Method.
Solution :
Computation of Project ARR:
Particulars Yr 1 Yr 2 Rs.
Yr 3 Rs.
Yr 4 Rs.
Yr 5 Rs.

Average
EBITD 2,50,000 3,00,000 3,50,000 4,00,000 5,00,000 3,60,000
Less: Dep. 3,00,000 2,10,000 1,47,000 1,02,900 72,030 1,66,386
EBIT (50,000) 90,000 2,03,000 2,97,100 4,27,970 1,93,614
Less: Tax@33.99%
-- 13,596 69,000 1,00,984 1,45,467 65,809
(50,000) 76,404 1,34,000 1,96,116 2,82,503 1,27,805
Book Value of Investment:
Begining 10,00,000 7,00,000 4,90,000 3,43,000 2,40,100 End
7,00,000 4,90,000 3,43,000 2,40,100 1,68,070 Average 8,50,000
5,95,000 4,16,500 2,91,550 2,04,085 4,71,427
ARR = Average EBIT (1-t) X 100 = 1, 27,805 X100 Average
Investment 4, 71,427 = 27.11%
Note: Unabsorbed depreciation of Yr. 1 is carried forward and setoff
against profits of Yr. 2. Tax is calculated on the balance of profits =
33.99% (90,000 – 50,000) = 13,596/-
EARNINGS PER SHARE (EPS)
EPS is one of the major criterion for capital investment appraisal.
The value of a firm is maximized if the market price of equity shares
is maximized.
EBIT I 1 Where EBIT = Earnings before Interest and Tax I =
Interest t = Corporate tax rate D = Preference Dividend n = no. of
equity shares
Note: The major drawback of this method is that it ignores cash flows,
timing and isk.
NET PRESENT VALUE (NPV) METHOD
Net Present Value = Present Value of Cash Inflows – Present
Value of Cash Outflows
The discounting is done by the entity’s weighted average cost of
capital.
The discounting factors is given by :
Where i = rate of interest per annum n = no. of years over which
discounting is made.
MERITS
(1) It recognizes the Time Value of Money.
(2) It considers total benefits during the entire life of the Project.

(3) This is applicable in case of mutually exclusive Projects.
(4) Since it is based on the assumptions of cash flows, it helps in
determining Shareholders Wealth.
DEMERITS
(1) This is not an absolute measure.
(2) Desired rate of return may vary from time to time due to changes
in cost of capital.
(3) This Method is not effective when there is disparity in economic
life of the projects.
(4) More emphasis on net present values. Initial investment is not
given due importance.
SOLVED PROBLEMS
Illustration 11:
Z Ltd. has two projects under consideration A & B, each costing Rs.
60 lacs.
The projects are mutually exclusive. Life for project A is 4 years &
project B is 3 years. Salvage value NIL for both the projects. Tax Rate
33.99%. Cost of Capital is 15%.
Net Cash Inflow (Rs. Lakhs)
At the end of the year Project A
Project B
P.V. @ 15%
1 60 100 0.870 2 110 130 0.756 3 120 50 0.685 4 50 — 0.572
Solution :
Computation of Net Present Value of the Projects.
Project A (Rs. lakhs) Yr. 1 Yr. 2 Yr. 3 Yr. 4
1. Net Cash Inflow 60.00 110.00 120.00 50.00 2. Depreciation 1
15.00 15.00 15.00 15.00 3.PBT (1–2) 45.00 95.00 105.00 35.00 4.
Tax @ 33.99% 15.30 32.29 35.70 11.90 5. PAT (3–4) 29.70 62.71
69.30 23.10 6. Net Cash Flow (PAT+Depn) 44.70 77.71 84.30 38.10
7. Discounting Factor 0.870 0.756 0.685 0.572
8. P.V. of Net Cash Flows 38.89 58.75 57.75 21.79 9. Total P.V. of
Net Cash Flow = 177.18 10. P.V. of Cash outflow (Initial
Investment) = 60.00
Net Present Value = 117.18
Project B

Yr. 1 Yr. 2 Yr. 3
1. Net Cash Inflow 100.00 130.00 50.00 2. Depreciation 20.00 20.00
20.00 3. PBT (1–2) 80.0110.00 30.00 4. Tax @ 33.99% 27.19 37.39
10.20 5. PAT (3–4) 52.81 72.61 19.80 6. Next Cash Flow (PAT +
Dep.) 72.81 92.61 39.80 7. Discounting Factor 0.870 0.756 0.685 8.
P.V. of Next Cash Flows 63.345 70.01 27.263 9. Total P.V. of Cash
Inflows = 160.621 10. P.V. of Cas Outflows (Initial Investment) =
60.00 Net Present Value = 100.621
As Project “A” has a higher Net Present Value, it has to be taken up.
INTERNAL RATE OF RETURN (IRR)
Internal Rate of Return is a percentage discount rate applied in capital
investment designs which brings the cost of a project and its expected
future cash flows into equality, i.e., NPV is zero.
MERITS:
(i) The Time Value of Money is considered. (ii) All cash flows in the
project are considered.
DEMERITS
(i) Possibility of multiple IRR, interpretation may be difficult.
If two projects with different inflow/outflow patterns are compared,
IRR will lead to peculiar situations.
(iii) If mutually exclusive projects with different investments, a
project with higher investment but lower IRR contributes more in
terms of absolute NPV and increases the shareholders’ wealth.
SOLVED PROBLEMS
llustration 1:
Project Cost Rs. 1,10,000
Cash Inflows: Year 1 Rs. 60,000 Year 2 Rs. 20,000 Year 3
Rs. 10,000 Year 4 Rs. 50,000
Calculate the Internal Rate of Return.
Solution: Internal Rate of Return will be calculated by the trial and
error method. The cash flow is not uniform. To have an approximate
idea about such rate, we can calculate the “Factor”. It represent the
same relationship of investment and cash inflows in case of payback
calculation: F = I/C Where F = Factor I = Original investment C =
Average Cash inflow per annum Factor for the project = 1, 10,000 =
3.14 35,000

The factor will be located from the table “P.V. of an Annuity of Rs.
1” representing number of years corresponding to estimated useful
life of the asset. The approximate value of 3.14 is located against 10%
in 4 years. We will now apply 10% and 12% to get (+) NPV and (–)
NPV [Which means IRR lies in between Year Cash Inflows (Rs.)P.V.
@ 10% DCFAT
P.V. @ 12% DCFAT
(Rs.) (Rs.)
1 60,000 0.909 54,540 0.893 53,580 2 20,000 0.826 16,520 0.797
15,940 3 10,000 0.751 7,510 0.712 7,120 4 50,000 0.683 34,150
0.636 31,800
P.V. of Inflows 1,12,720 1,08,440 Less : Initial Investment 1,10,000
1,10,000
NPV 2,720 (1,560)
Graphically, For 2%, Difference = 4,280
10% 12% NVP 2,720 (1,560)
IRR may be calculated in two ways :
Forward Method : Taking 10%, (+) NPV
IRR = 10% + NPV at 10% x Difference in Rate Total Difference
= 10% + 2720 X 2% 4280 = 10% + 1.27% = 11.27%
Backward Method: Taking 12%, (–) NPV
IRR = 12% + (1560) X 2% 4280
= 12% – 0.73% = 11.27%
The decision rule for the internal rate of return is to invest in a project
if its rate of return is greater than its cost of capital.
For independent projects and situations involving no capital rationing,
then:
Situation Signifies Decision IRR = Cost of Capital The investment is
expected not to change shareholder wealth
Indifferent between Accepting & Rejecting
IRR > Cost of Capital The investment is expected to increase
shareholders wealth
Accept
IRR < Cost of Capital The investment is expected to decrease
shareholders wealth
Reject

NPV-IRR CONFLICT
Let us consider two mutually exclusive projects A & B.
Project A Project B Decision
Cost of Capital 10% 10% IRR 13% 11% Project A NPV 1,00,000
1,10,000 Project B When evaluating mutually exclusive projects, the
one with the highest IRR may not be the one with the best NPV.
The conflict between NPV and IRR for the evaluation of mutually
exclusive projects is due to the reinvestment assumption:
x NPV assumes cash flows reinvested at the cost of capital. x IRR
assumes cash flows reinvested at the internal rate of return.
The reinvestment assumption may cause different decisions due to: x
Timing difference of cash flows. x Difference in scale of operations. x
Project life disparity.
Terminal Value Method
Assumption: (1) Each cash flow is reinvested in another project at a
predetermined rate of interest. (2) Each cash inflow is reinvested
elsewhere immediately after the completion of the project.
Initial investment Rs. 20 lacs. Expected annual cash flows Rs. 6 lacs
for 10 years. Cost of Capital @ 15%. Calculate Profitability Index.
Solution: Cumulative discounting factor @ 15% for 10 years = 5.019
P.V. of inflows = 6.00 × 5.019 = Rs. 30.114 lacs. Profitability Index
= P.V. of Inflows = 30.114 = 1.51 P.V. of Outflows 20
Decision: The project should be accepted. Discounted Payback Period
In Traditional Payback period, the time value of money is not
considered. Under discounted payback period, the expected future
cash flows are discounted by applying the appropriate rate, i.e., the
cost of capital.
Illustration
Initial Investment Rs. 1,00,000 Cost of Capital @ 12% p.a.
Expected Cash Inflows Yr. 1 Rs. 25,000 Yr. 2 Rs. 50,000 Yr. 3
Rs. 75,000 Yr. 4 Rs. 1,00,000 Yr. 5 Rs. 1,50,000
Calculate Discounted Payback Period.
Solution:
Year
Cash Inflows (Rs.)
Discounting Factor @ 12% Discounted Cash Flows (Rs.)

Cumulative DCF (Rs.)
1 25,000 0.8929 22,323 22,323 2 50,000 0.7972 39,860 62,183 3
75,000 0.7117 53,378 1,15,561 4 1,00,000 0.6355 63,550 1,79,111 5
1,50,000 0.5674 85,110 2,64,221
The recovery was made between 2nd and 3rd year.
Discounted Payback Period = 1,00,000 62,183 2 Years 12 1,15,561
62,183
u = 37,817 2 Years 12 53,378
Solution:
Year
Cash Inflows (Rs.)
Discounting Factor @ 12%
Discounted Cash Flows (Rs.)
Cumulative DCF (Rs.)
1 25,000 0.8929 22,323 22,323 2 50,000 0.7972 39,860 62,183 3
75,000 0.7117 53,378 1,15,561 4 1,00,000 0.6355 63,550 1,79,111 5
1,50,000 0.5674 85,110 2,64,221
The recovery was made between 2nd and 3rd year.
Discounted Payback Period =
1,00,000 62,183 2 Years 12 1,15,561 62,183 u
= 37,817 2 Years 12 53,378 u
= 2 years 8 ½ Months.
Working Capital:The term working capital is commonly used for the
capital required for dayto-day working in a business concern, such as
for purchasing raw material, for meeting day-to-day expenditure on
salaries, wages, rents rates, advertising etc. But there are much
disagreement among various financial authorities (Financiers,
accountants, businessmen and economists) as to the exact meaning of
the term working capital.
Working capital refers to the circulating capital required to meet the
day to day operations of a business firm. Working capital may be
defined by various authors as follows: 1. According to Weston &
Brigham - "Working capital refers to a firm's investment in short term
assets, such as cash amounts receivables, inventories etc." 2.
"Working capital means current assets." — Mead, Baker and Malott
3. "The sum of the current assets is the working capital of the

business" — J.S.Mill Working capital is defined as "the excess of
current assets over current liabilities and provisions". But as per
accounting terminology, it is difference between the inflow and
outflow of funds. In the Annual Survey of Industries (1961), working
capital is defined to include "Stocks of materials, fuels, semi-finished
goods including work-in-progress and finished goods and by-
products; cash in hand and bank and the algebraic sum of sundry
creditors as represented by (a) outstanding factory payments e.g. rent,
wages, interest and dividend; b) purchase of goods and services; c)
short-term loans and advances and sundry debtors comprising
amounts due to the factory on account of sale of goods and services
and advances towards tax payments". The term "working capital" is
often referred to "circulating capital" which is frequently used to
denote those assets which are changed with relative speed from one
form to another i.e., starting from cash, changing to raw materials,
converting into work-inprogress and finished products, sale of
finished products and ending with realization of cash from debtors.
Working capital has been described as the "life blood of any business
which is apt because it constitutes a cyclically flowing stream through
the business. Working Capital may be classified in two ways A)
Concept based working capital B) Time based working capital
CONCEPTS OF WORKING CAPITAL 1. Gross Working
Capital: It refers to the firm's investment in total current or
circulating assets. 2. Net Working Capital: The term "Net Working
Capital" has been defined in two different ways: i. It is the excess of
current assets over current liabilities. This is, as a matter of fact, the
most commonly accepted definition. Some people define it as only the
difference between current assets and current liabilities. The former
seems to be a better definition as compared to the latter. ii. It is that
portion of a firm's current assets which is financed by long-term
funds. 3. Permanent Working Capital: This refers to that minimum
amount of investment in all current assets which is required at all
times to carry out minimum level of business activities. In other
words, it represents the current assets required on a continuing basis
over the entire year. Tandon Committee has referred to this type of
working capital as "Core current assets". 4. Temporary Working

Capital: The amount of such working capital keeps on fluctuating
from time to time on the basis of business activities. In other words, it
represents additional current assets required at different times during
the operating year. For example, extra inventory has to be maintained
to support sales during peak sales period. Similarly, receivable also
increase and must be financed during period of high sales. On the
other hand investment in inventories, receivables, etc., will decrease
in periods of depression. Suppliers of temporary working capital can
expect its return during off season when it is not required by the firm.
Hence, temporary working capital is generally financed from short-
term sources of finance such as bank credit. 5. Negative Working
Capital: This situation occurs when the current liabilities exceed the
current assets. It is an indication of crisis to the firm.
NEED FOR WORKING CAPITAL Working capital is needed till a
firm gets cash on sale of finished products. It depends on two factors:
i. Manufacturing cycle i.e. time required for converting the raw
material into finished product; and ii. Credit policy i.e. credit period
given to Customers and credit period allowed by creditors. Thus, the
sum total of these times is called an "Operating cycle" and it consists
of the following six steps: 1. Conversion of cash into raw materials. 2.
Conversion of raw materials into work-in-process. 3. Conversion of
work-in-process into finished products. 4. Time for sale of finished
goods—cash sales and credit sales. 5. Time for realization from
debtors and Bills receivables into cash. 6. Credit period allowed by
creditors for credit purchase of raw materials, inventory and creditors
for wages and overheads. In case of trading concern, the operating
cycle will be Cash o Stock o Debtors o Cash DETERMINANTS OF
WORKING CAPITAL: The factors influencing the working capital
decisions of a firm may be classified as two groups, such as internal
factors and external factors. The internal factors includes, nature of
business size of business, firm's product policy, credit policy,
dividend policy, and access to money and capital markets, growth and
expansion of business etc. The external factors include business
fluctuations, changes in the technology, infrastructural facilities,
import policy and the taxation policy etc. These factors are discussed
in brief in the following lines. I. Internal Factors 1. Nature and size

of the business The working capital requirements of a firm are
basically influenced by the nature and size of the business. Size may
be measured in terms of the scale of operations. A firm with larger
scale of operations will need more working capital than a small firm.
Similarly, the nature of the business - influence the working capital
decisions. Trading and financial firms have less investment in fixed
assets. But require a large sum of money to be invested in working
capital. Retail stores, business units require larger amount of working
capital, where as, public utilities need less working capital and more
funds to invest in fixed assets. 2. Firm's production policy The
firm's product material and completes with the production of finished
goods. On the other hand production policy is uniform production
policy or seasonal production policy etc., also influences the working
capital decisions. Larger the manufacturing cycle and uniform
production policy -larger will be the requirement of working capital.
The working capital requirement will be higher with varying
production schedules in accordance with the changing demand. 3.
Firm's credit policy The credit policy of a firm influences credit
policy of working capital. A firm following liberal credit policy to all
customers require funds. On the other hand, the firm adopting strict
credit policy and grant credit facilities to few potential customers will
require less amount of working capital. 4. Availability of credit The
working capital requirements of a firm are also affected by credit
terms granted by its suppliers - i.e. creditors. A firm will need less
working capital if liberal credit terms are available to it. Similarly, the
availability of credit from banks also influences the working capital
needs of the firm. A firm, which can get bank credit easily on
favorable conditions will be operated with less working capital than a
firm without such a facility. 5. Growth and expansion of business
Working capital requirement of a business firm tend to increase in
correspondence with growth in sales volume and fixed assets. A
growing firm may need funds to invest in fixed assets in order to
sustain its growing production and sales. This will, in turn, increase
investment in current assets to support increased scale of operations.
Thus, a growing firm needs additional funds continuously. 6. Profit
margin and dividend policy The magnitude of working capital in a

firm is dependent upon its profit margin and dividend policy. A high
net profit margin contributes towards the working capital pool. To the
extent the net profit has been earned in cash, it becomes a source of
working capital. This depends upon the dividend policy of the firm.
Distribution of high proportion of profits in the form of cash
dividends results in a drain on cash resources and thus reduces
company's working capital to that extent. The working capital
position of the firm is strengthened if the management follows
conservative dividend policy and vice versa. 7. Operating efficiency
of the firm: Operating efficiency means the optimum utilization of a
firm's resources at minimum cost. If a firm successfully controls
operating 281 cost, it will be able to improve net profit margin which,
will, in turn, release greater funds for working capital purposes. 8.
Co-ordinating activities in firm The working capital requirements of
a firm is depend upon the co-ordination between production and
distribution activities. The greater and effective the co-ordinations, the
pressure on the working capital will be minimized. In the absence of
co-ordination, demand for working capital is reduced.
II. External Factors 1. Business fluctuations Most firms experience
fluctuations in demand for their products and services. These business
variations affect the working capital requirements. When there is an
upward swing in the economy, sales will increase, correspondingly,
the firm's investment in inventories and book debts will also increase.
Under boom, additional investment in fixed assets may be made by
some firms to increase their productive capacity. This act of the firm
will require additional funds. On the other hand when, there is a
decline in economy, sales will come down and consequently the
conditions, the firm try to reduce their short-term borrowings.
Similarly the seasonal fluctuations may also affect the requirement of
working capital of a firm.
2. Changes in the technology The technological changes and
developments in the area of production can have immediate effects on
the need for working capital. If the firm wish to install a new machine
in the place of old system, the new system can utilize less expensive
raw materials, the inventory needs may be reduced there by working
capital needs.

3. Import policy Import policy of the Government may also effect
the levels of working capital of a firm since they have to arrange
funds for importing goods at specified times.
4. Infrastructural facilities The firms may require additional funds
to maintain the levels of inventory and other current assets, when
there is good infrastructural facilities in the company like,
transportation and communications.
5. Taxation policy The tax policies of the Government will influence
the working capital decisions. If the Government follow regressive
taxation policy, i.e. imposing heavy tax burdens on business firms,
they are left with very little profits for distribution and retention
purpose. Consequently the firm has to borrow additional funds to
meet their increased working capital needs. When there is a
liberalized tax policy, the pressure on working capital requirement is
minimized. Thus the working capital requirement of a firm is
influenced by the internal and external factors.
MEASUREMENT OF WORKING CAPITAL There are 3
methods for assessing the working capital requirement as explained
below: a) Percent of Sales Method Based on the past experience,
some percentage of sale may be taken for determining the quantum of
working capital b) Regression Analysis Method The relationship
between sales and working capital and its various components may be
plotted on Scatter diagram and the average percentage of past 5 years
may be ascertained. This average percentage of sales may be taken as
working capital. Similar exercise may be carried out at the beginning
of the year for assessing the working capital requirement. This
method is suitable for simple as well as complex situations. c)
Operating Cycle Method As a first step, we have to compute the
operating cycle as follows: i) Inventory period: Number of days
consumption in stock = I / M 365 Where I - Average inventory during
the year M = Materials consumed during the year ii) Work-in-process:
Number of days of work in process = W / K 365 Where W = Average
work-in-process during the year K = Cost of work in process i.e.
Material + Labour + Factory Overheads. iii) Finished products
inventory period = G / F 365 Where G = Average finished products
inventory during the year F = Cost of finished goods sold during the

year iv) Average collection period of Debtors = D / S 365 Where D =
Average Debtors balances during the year S = Credit sales during the
year 283 v) Credit period allowed by Suppliers = C = P 365 Where C
= Average creditors' balances during the year P = credit purchases
during the year vi) Minimum cash balance to be kept daily. Formula:
O.C. = M + W + F + D – C Note : It is also known as working capital
cycle. Operating cycle is the total time gap between the purchase of
raw material and the receipt from Debtors.
IMPORTANCE OR ADVANTAGES OF ADEQUATE
WORKING CAPITAL Working capital is the life blood and nerve
centre of a business. Just as circulation of blood is essential in the
human body for maintaining life, working capital is very essential to
maintain the smooth running of a business. No business can run
successfully without an adequate amount of working capital. The
main advantages of maintaining adequate amount of working capital
are as follows: 1. Solvency of the business: Adequate working
capital helps in maintaining solvency of the business by providing
uninterrupted flow of production.
2. Goodwill: Sufficient working capital enables a business concern to
make prompt payments and hence helps in creating and maintaining
goodwill.
3. Easy loans: A concern having adequate working capital, high
solvency and good credit standing can arrange loans from banks and
other on easy and favourable terms.
4. Cash discounts: Adequate working capital also enables a concern
to avail cash discounts on the purchases and hence it reduces costs. 5.
Regular supply of raw materials: Sufficient working capital ensures
regular supply of raw materials and continuous production.
6. Regular payment of salaries, wages and other day-to-day
commitments: A company which has ample working capital can make
regular payment of salaries, wages and other day-today commitments
which raises the morale of its employees, increases their efficiency,
reduces wastages and costs and enhances production and profits.
7. Exploitation of favourable market conditions: Only concerns with
adequate working capital can exploit favourable market conditions

such as purchasing its requirements in bulk when the prices are lower
and by holding its inventories for higher prices.
8. Ability to face crisis: Adequate working capital enables a concern
to face business crisis in emergencies such as depression because
during such periods, generally, there is much pressure on working
capital.
9. Quick and regular return on investments: Every Investor wants
a quick and regular return on his investments. Sufficiency of working
capital enables a concern to pay quick and regular dividends to its
investors as there may not be much pressure to plough back profits.
This gains the confidence of its investors and creates a favourable
market to raise additional funds i.e., the future. 10. High morale:
Adequacy of working capital creates an environment of security,
confidence, high morale and creates overall efficiency in a business.
EXCESS OR INADEQUATE WORKING CAPITAL Every
business concern should have adequate working capital to run its
business operations. It should have neither redundant or excess
working capital nor inadequate or shortage of working capital. Both
excess as well as short working capital positions are bad for any
business. However, out of the two, it is the inadequacy of working
capital which is more dangerous from the point of view of the firm.
Disadvantages of Redundant or Excessive Working Capital 1.
Excessive Working Capital means ideal funds which earn no profits
for the business and hence the business cannot earn a proper rate of
return on its investments.
2. When there is a redundant working capital, it may lead to
unnecessary purchasing and accumulation of inventories causing
more chances of theft, waste and losses.
3. Excessive working capital implies excessive debtors and defective
credit policy which may cause higher incidence of bad debts.
4. It may result into overall inefficiency in the organization.
5. When there is excessive working capital, relations with banks and
other financial institutions may not be maintained.
6. Due to low rate of return on investments, the value of shares may
also fall.

7. The redundant working capital gives rise to speculative
transactions.
Disadvantages or Dangers of Inadequate Working Capital 1. A
concern which has inadequate working capital cannot pay its short-
term liabilities in time. Thus, it will lose its reputation and shall not be
able to get good credit facilities.
2. It cannot buy its requirements in bulk and cannot avail of
discounts, etc.
3. It becomes difficult for the firm to exploit favourable market
conditions and undertake profitable projects due to lack of working
capital.
4. The firm cannot pay day-to-day expenses of its operations and it
creates inefficiencies, increases costs and reduces the profits of the
business.
5. It becomes impossible to utilize efficiently the fixed assets due to
non-availability of liquid funds.
6. The rate of return on investments also falls with the shortage of
working capital.
WORKING CAPITAL FINANCING 1. Accruals The major
accrual items are wages and taxes. These are simply what the firm
owes to its employees and to the government.
2. Trade Credit Trade credit represents the credit extended by the
supplier of goods and services. It is a spontaneous source of finance in
the sense that it arises in the normal transactions of the firm without
specific negotiations, provided the firm is considered creditworthy by
its supplier. It is an important source of finance representing 25% to
50% of short-term financing.
3. Working Capital Advance by Commercial Banks Working capital
advance by commercial banks represents the most important source
for financing current assets. Forms of Bank Finance: Working capital
advance is provided by commercial banks in three primary ways: (i)
cash credits / overdrafts, (ii) loans, and (iii) purchase / discount of
bills. In addition to these forms of direct finance, commercials banks
help their customers in obtaining credit from other sources through
the letter of credit arrangement. i. Cash Credit / Overdrafts: Under a
cash credit or overdraft arrangement, a pre-determined limit for

borrowing is specified by the bank. The borrower can draw as often as
required provided the out standings do not exceed the cash credit /
overdraft limit. ii. Loans: These are advances of fixed amounts which
are credited to the current account of the borrower or released to him
in cash. The borrower is charged with interest on the entire loan
amount, irrespective of how much he draws. iii. Purchase / Discount
of Bills: A bill arises out of a trade transaction. The seller of goods
draws the bill on the purchaser. The bill may be either clean or
documentary (a documentary bill is supported by a document of title
to gods like a railway receipt or a bill of lading) and may be payable
on demand or after a usance period which does not exceed 90 days.
On acceptance of the bill by the purchaser, the seller offers it to the
bank for discount /purchase. When the bank discounts / purchases the
bill it releases the funds to the seller. The bank presents the bill to the
purchaser (the acceptor of the bill) on the due date and gets its
payment. iv. Letter of Credit: A letter of credit is an arrangement
whereby a bank helps its customer to obtain credit from its
(customer's) suppliers. When a bank opens a letter of credit in favour
of its customer for some specific purchases, the bank undertakes the
responsibility to honour the obligation of its customer, should the
customer fail to do so. Regulation of Bank Finance Concerned about
such a distortion in credit allocation, the Reserve Bank of India (RBI)
has been trying, particularly from the mid 1960s onwards, to bring a
measure of discipline among industrial borrowers and to redirect
credit to the priority sectors of the economy. From time to time, the
RBI issues guidelines and directives relating to matters like the norms
for inventory and receivables, the maximum permissible bank finance,
the form of assistance, the informati on and reporting system, and the
credit monitoring mechanism. The important guidelines and directives
have stemmed from the recommendations of various committees such
as the Dehejia Committee, the Tandon Committee, the Chore
Committee, and the Marathe Committee.
However, in recent years, in the wake of financial liberalisation, the
RBI has given freedom to the boards of individual banks in all matters
relating to working capital financing. From the mid-eighties onwards,
special committees were set up by the RBI to prescribe norms for

several other industries and revise norms for some industries covered
by the Tandon Committee. Maximum Permissible Bank Finance: The
Tandon Committee had suggested three methods for determining the
maximum permissible bank finance (MPBF). Lending Norms The
recommendation of the Tandon Committee regarding the "Lending
norms" has far - reaching implications. The lending norms have been
suggested in view of the realization that the banker's role as a lender
in only to supplement the borrower's resources and not to meet his
entire working capitals needs. In the context of this approach, the
committee has suggested three alternative methods for working out
the maximum permissible level of bank borrowings. Each successive
method reduces the involvement of short-term bank credit to finance
the current assets. First Method: According to this method, the
borrower will have to contribute a minimum of 25% of the working
capital gap from longterm funds, i.e., owned funds and term
borrowings. This will give a current ratio of 1.17:1. The term
workingcapital gap refers to the total of current assets less current
liabilities other than bank borrowings. This can be understood with
the help of following example: Example 1 Rs. Total Current assets
required by the borrower as per norms Current liabilities 20,000 5,000
Amount of maximum permissible bank borrowings as per the first
method can be ascertained as follows: - Working Capital gap (Rs.
20,000 - Rs. 5,000) 15,000 Less: 25% from long-term sources 3,750
Maximum permissible bank borrowings 11,250 Second Method:
Under this method the borrower has to provide the minimum of 25%
of the total current assets that will give a current ratio of 1.33:1. 288
Example 2: On the basis of the data given in Example 1, the
maximum permissible bank borrowings as per second method can be
ascertained as follows: Rs. Current assets as per norms 20,000 Less:
25% to be provided from long - term funds 5,000 15,000 Less:
Current liabilities other than bank borrowings 5,000 Maximum
permissible bank borrowings 10,000 Third Method : In this method,
the borrower's contribution from long term funds will be to the extent
of the entire core current assets and a minimum of 25% of the balance
of the current assets. The term core current assets refers to the
absolute minimum level of investment in all current assets which is

required at all times to carry out minimum level of business activities.
Example 3: On the basis of the information given in Example 1, the
amount of maximum permissible bank finance can be arrived at the
follows if the core current assets are Rs. 2,000 Rs. Current assets as
per norms 20,000 Less: Core Current Assets 2,000 18,000 Less: 25%
to be provided from long-term funds 4,500 13,500 Less: Current
Liabilities 5,000 Maximum permissible bank borrowings 8,500 It will
thus be seen that in the third method current ratio has further
improved. Reserve Bank's directive: The Reserve Bank of India
accepted the recommendations of the Tandon Committee. It instructed
the commercial banks in 1976 to put all the borrowers having
aggregate credit limits from banking system in excess of Rs.10 lakhs,
under the first method of lending. Public Deposits Many firms, large
and small, have solicited unsecured deposits from the public in recent
years, mainly to finance their working capital requirements. Inter-
corporate Deposits A deposit made by one company with another,
normally for a period up to six months, is referred to as an inter-
corporate deposit. Such deposits are usually of three types. 289
a. Call Deposits : In theory, a call deposit is withdrawable by the
lender on giving a day's notice. In practice, however, the lender has to
wait for at least three days. The interest rate on such deposits may be
around 10 percent per annum.
b. Three-months Deposits : More popular in practice, these deposits
are taken by borrowers to tide over a short-term cash inadequacy that
may be caused by one or more of the following factors: disruption in
production, excessive imports of raw material, tax payment, delay in
collection, dividend payment, and unplanned capital expenditure. The
interest rate on such deposits is around 12 percent per annum.
c. Six-months Deposits : Normally, lending companies do not extend
deposits beyond this time frame. Such deposits, usually made with
first-class borrowers, and carry interest rate of around 15 percent per
annum. Short-term Loans from Financial Institutions The Life
Insurance Corporation of India and the General Insurance Corporation
of India provide short-term loans to manufacturing companies with an
excellent track record. Rights Debentures for Working Capital Public
limited companies can issue "Rights" debentures to their shareholders

with the object of augmenting the long-term resources of the company
for working capital requirements. The key guidelines applicable to
such debentures are as follows: (a) The amount of the debenture issue
should not exceed
(a) 20% of the gross current assets, loans, and advances minus the
long-term funds presently available for financing working capital, or
(b) 20% of the paid-up share capital, including reference capital and
free reserves, whichever is the lower of the two.
(b) The debt. -equity ratio, including the proposed debenture issue,
should not exceed 1:1.
(c) The debentures shall first be offered to the existing Indian resident
shareholders of the company on a pro rata basis.
Commercial Paper
represents short-term unsecured promissory notes issued by firms
which enjoy a fairly high credit rating. Generally, large firms with
considerable financial strength are able to issue commercial paper.
The important features of commercial paper are as follows:
(a) The maturity period of commercial paper usually ranges from 90
days to 360 days.
(b) Commercial paper is sold at a discount from its face value and
redeemed at its face value. Hence the implicit interest rate is a
function of the size of the discount and the period of maturity.
(c) Commercial paper is directly placed with investors who intend
holding it till its maturity. Hence there is no well developed secondary
market for commercial paper.
Factoring: Factoring, as a fund based financial service, provides
resources to finance receivables as well as facilitates the collection of
receivables. It is another method of raising short-term finance through
account receivable credit offered by commercial banks and factors. A
commercial bank may provide finance by discounting the bills or
invoices of its customers. Thus, a firm gets immediate payment for
sales made on credit. A factor is a financial institution which offers
services relating to management and financing of debts arising out of
credit sales. Factoring is becoming popular all over the world on
account of various services offered by the institutions engaged in it.
Factors render services varying from bill discounting facilities offered

by commercial banks to a total take over of administration of credit
sales including maintenance of sales ledger, collection of accounts
receivables, credit control and protection from bad debts, provision of
finance and rendering of advisory services to their clients. Factoring,
may be on a recourse basis, where the risk of bad debts is borne by the
client, or on a non-recourse basis, where the risk of credit is borne by
the factor. At present, factoring in India is rendered by only a few
financial institutions on a recourse basis. However, the Report of the
Working Group on Money Market (Vaghul Committee) constituted
by the Reserve Bank of India has recommended that banks should be
encouraged to set up factoring divisions to provide speedy finance to
the corporate entities. In spite of many services offered by factoring, it
suffers from certain limitations.
The most critical fall outs of factoring include (i) the high cost of
factoring as compared to other sources of shortterm finance, (ii) the
perception of financial weakness about the firm availing factoring
services, and (iii) adverse impact of tough stance taken by factor,
against a defaulting buyer, upon the borrower resulting into reduced
future sales.
FINANCING AND POLICIES OF WORKING CAPITAL, AND
THEIR IMPACT After arriving the estimation of working capital for
any firm, the next step is how to finance the working capital
requirement. It is of two sources of financing: 1. Short –term 2. Long
– term Short-term financing refers to borrowing funds or raising credit
for a maximum of 1 year period i.e., the debt is payable within a year
at the most. Whereas, the Long - term financing refers to the
borrowing of funds or raising credit for one year or more. The finance
manager has to mix funds from these two sources optimally to ensure
profitability and liquidity. The mixing of finances from long-term and
short term should be such that the firm should not face either short of
funds or idle funds. Thus, the financing of working capital should not
result in either idle or shortage of cash funds. Policy is a guideline in
taking decisions of business. In working capital financing, the
manager has to take a decision of mixing the two components i.e.,
long term component of debt and short term component of debt. The
policies for financing of working capital are divided into three

categories. Firstly, conservative financing policy in which the
manager depends more on long term funds. Secondly, aggressive
financing policy in which the manager depends more on short term
funds, and third, are is a moderate policy which suggests that the
manager depends moderately on both long tem and short-term funds
while financing. These policies are shown diagrammatically here
under. Matching Approach The question arising here is how to mix
both short term and long term funds while financing required working
capital. The guiding approach is known as 'matching approach'. It
suggests that if the need is short term purpose, raise short - term loan
or credit and if the need is for a long term, one should raise long term
loan or credit. Thus, maturity period of the loan is to be matched with
the purpose and for how long. This is called matching approach. This
matches the maturity period of the loan with the period for how long
working capital requires. The following diagram shows the graphic
presentation of the matching approach.
Types of Funds Working capital requirement Short – term -
Seasonal Working Capital Long – term - Permanent Working
Capital Equity Capital - Fixed Assets Impact of Working Capital
Policies A firm's sales are Rs. 25 lakhs, and having an EBIT - Rs. 3
lakhs. It has fixed assets of Rs. 8 lakhs. The firm is thinking to hold
current assets of different size of Rs. 5 lakhs; Rs. 6 lakhs or Rs. 8
lakhs. Assuming profits and fixed assets do not vary, the impact of
these working capital policies are in the following manner which is
explained is a hypothetical illustration: Types of Policy (Rs. in lakhs)
Aggressive Moderate Conservative Sales 25 25 25 EBIT 3 3 3
Current Assets 5 6 8 Fixed Assets 8 8 8 Total Assets 13 14 16 Return
on Assets % (EBIT/total assets) 23.07 21.42 18.75 Lower the level of
current assets (aggressive) higher the returns (23.07 percent) higher
the level of current assets (conservative) lower the returns (18.75
percent). 293 Optimal Size of Current Assets As we have discussed in
the earlier paragraphs, current assets and their size depends upon
several factors. Arriving appropriate size of current assets such as
cash, raw materials, finished goods and debtors is a challenge to the
financial manager of a firm. It happens some times excess or shortage.
We have also discussed in the fore-gone paragraphs about the evils of

excess working capital and inadequate working capital. Very few
firms arrive optimum level of working capital by their sheer
experience and scientific approach. The ratio of current assets to fixed
assets helps in measuring the performance of working capital
management. The higher the ratio, conservative the firm is in
maintaining its current assets and lower the ratio, aggressive the firm
is in maintaining its current assets. So every firm should balance their
level of current assets and make it optimum. Liquidity Vs.
Profitability Any exercise in working capital management will
influence either liquidity or profitability. The working capital
management is a razor edge exercise for financial manager of an
enterprise. In this context the financial manager has to take several
decisions of routine and non-routine such as: Sufficient cash balance
to be maintained; To raise long term or short term loans decide the
rate of interest and the time of repayment; Decide the purchase policy
to buy or not to buy materials; To determine the economic order
quantity for inputs, To fix the price at which to buy the inputs if any;
To sell for credit or not and terms of credit; To decide the terms of
purchase; To decide the credit period and extent of credit; In all these
aspects the financial manager has to take decisions carefully so that
the firm's twin objectives such as profitability and solvency are not
affected. Trade off between Liquidity and Profitability: If a firm
maintains huge amount of current assets its profitability will be
affected though it protects liquidity. If a firm maintains low current
assets, its liquidity is of course weak but the firm's profitability will be
high. The trade off between liquidity and illiquidity are shown in the
following diagram.

UNIT 4
Introduction to Indian Financial System –
The financial system of a country is an important tool for economic
development of the country, as it helps in creation of wealth by
linking savings with investments. It facilitates the flow of funds form
the households (savers) to business firms (investors) to aid in wealth
creation and development of both the parties. A financial system
functions as an intermediary between savers and investors. It
facilitates the flow of funds from the areas of surplus to the areas of
deficit. It is concerned about the money, credit and finance. These
three parts are very closely interrelated with each other and depend on
each other.
A financial system may be defined as a set of institutions, instruments
and markets which promotes savings and channels them to their most
efficient use. It consists of individuals (savers), intermediaries,
markets and users of savings (investors). In the worlds of Van Horne,
“financial system allocates savings efficiently in an economy to
ultimate users either for investment in real assets or for consumption”.
According to Prasanna Chandra, “financial system consists of a
variety of institutions, markets and instruments related in a systematic
manner and provide the principal means by which savings are
transformed into investments”. Thus financial system is a set of
complex and closely interlinked financial institutions, financial
markets, financial instruments and services which facilitate the
transfer of funds. Financial institutions mobilise funds from suppliers
and provide these funds to those who demand them. Similarly, the
financial markets are also required for movement of funds from savers
to intermediaries and from intermediaries to investors. In short,
financial system is a mechanism by which savings are transformed
into investments. Functions of Financial System The financial system
of a country performs certain valuable functions for the economic
growth of that country. The main functions of a financial system may
be briefly discussed as below: 1. Saving function: An important
function of a financial system is to mobilise savings and channelize
them into productive activities. It is through financial system the
savings are transformed into investments. 2. Liquidity function: The

most important function of a financial system is to provide money and
monetary assets for the production of goods and services. Monetary
assets are those assets which can be converted into cash or money
easily without loss of value. All activities in a financial system are
related to liquidity-either provision of liquidity or trading in liquidity.
3. Payment function: The financial system offers a very convenient
mode of payment for goods and services. The cheque system and
credit card system are the easiest methods of payment in the economy.
The cost and time of transactions are considerably reduced. 4. Risk
function: The financial markets provide protection against life, health
and income risks. These guarantees are accomplished through the sale
of life, health insurance and property insurance policies.
Information function: A financial system makes available price-
related information. This is a valuable help to those who need to take
economic and financial decisions. Financial markets disseminate
information for enabling participants to develop an informed opinion
about investment, disinvestment, reinvestment or holding a particular
asset. 6. Transfer function: A financial system provides a mechanism
for the transfer of the resources across geographic boundaries.
7. Reformatory functions: A financial system undertaking the
functions of developing, introducing innovative financial
assets/instruments services and practices and restructuring the existing
assts, services etc, to cater the emerging needs of borrowers and
investors (financial engineering and re engineering).
8. Other functions: It assists in the selection of projects to be
financed and also reviews performance of such projects periodically.
It also promotes the process of capital formation by bringing together
the supply of savings and the demand for investible funds.
Role and Importance of Financial System in Economic
Development
1. It links the savers and investors. It helps in mobilizing and
allocating the savings efficiently and effectively. It plays a crucial role
in economic development through saving-investment process. This
savings – investment process is called capital formation.
2. It helps to monitor corporate performance.

3. It provides a mechanism for managing uncertainty and controlling
risk.
4. It provides a mechanism for the transfer of resources across
geographical boundaries.
5. It offers portfolio adjustment facilities (provided by financial
markets and financial intermediaries).
6. It helps in lowering the transaction costs and increase returns. This
will motivate people to save more.
7. It promotes the process of capital formation. 8. It helps in
promoting the process of financial deepening and broadening.
Financial deepening means increasing financial assets as a percentage
of GDP and financial broadening means building an increasing nu
mber and variety of participants and instruments. In short, a financial
system contributes to the acceleration of economic development. It
contributes to growth through technical progress.
Structure of Indian Financial System Financial structure refers to
shape, components and their order in the financial system. The Indian
financial system can be broadly classified into formal (organised)
financial system and the informal (unorganised) financial system. The
formal financial system comprises of Ministry of Finance, RBI, SEBI
and other regulatory bodies. The informal financial system consists of
individual money lenders, groups of persons operating as funds or
associations, partnership firms consisting of local brokers, pawn
brokers, and non-banking financial intermediaries such as finance,
investment and chit fund companies.
The formal financial system comprises financial institutions,
financial markets, financial instruments and financial services.
I. Financial Institutions Financial institutions are the participants
in a financial market. They are business organizations dealing in
financial resources. They collect resources by accepting deposits from
individuals and institutions and lend them to trade, industry and
others. They buy and sell financial instruments. They generate
financial instruments as well. They deal in financial assets. They
accept deposits, grant loans and invest in securities.
II. Financial institutions are the business organizations that act as
mobilises of savings and as purveyors of credit or finance. This means

financial institutions mobilise the savings of savers and give credit or
finance to the investors. They also provide various financial services
to the community. They deal in financial assets such as deposits,
loans, securities and so on. On the basis of the nature of activities,
financial institutions may be classified as: (a) Regulatory and
promotional institutions, (b) Banking institutions, and (c) Non-
banking institutions. 1. Regulatory and Promotional Institutions:
Financial institutions, financial markets, financial instruments and
financial services are all regulated by regulators like Ministry of
Finance, the Company Law Board, RBI, SEBI, IRDA, Dept. of
Economic Affairs, Department of Company Affairs etc. The two
major Regulatory and Promotional Institutions in India are Reserve
Bank of India (RBI) and Securities Exchange Board of India (SEBI).
Both RBI and SEBI administer, legislate,supervise, monitor, control
and discipline the entire financial system. RBI is the apex of all
financial institutions in India. All financial institutions are under the
control of RBI. The financial markets are under the control of SEBI.
Both RBI and SEBI have laid down several policies, procedures and
guidelines. These policies, procedures and guidelines are changed
from time to time so as to set the financial system in the right
direction.
2. Banking Institutions: Banking institutions mobilise the savings of
the people. They provide a mechanism for the smooth exchange of
goods and services. They extend credit while lending money. They
not only supply credit but also create credit. There are three basic
categories of banking institutions. They are commercial banks, co-
operative banks and developmental banks.
3. Non-banking Institutions: The non-banking financial institutions
also mobilize financial resources directly or indirectly from the
people. They lend the financial resources mobilized. They lend funds
but do not create credit. Companies like LIC, GIC, UTI, Development
Financial Institutions, Organisation of Pension and Provident Funds
etc. fall in this category. Non-banking financial institutions can be
categorized as investment companies, housing companies, leasing
companies, hire purchase companies, specialized financial institutions
(EXIM Bank etc.) investment institutions, state level institutions etc.

Financial institutions are financial inte rmediaries. They intermediate
between savers and investors. They lend money. They also mobilise
savings.
II. Financial Markets Financial markets are another part or component
of financial system. Efficient financial markets are essential for
speedy economic development. The vibrant financial market enhances
the efficiency of capital formation. It facilitates the flow of savings
into investment. Financial markets bridge one set of financial
intermediaries with another set of players. Financial markets are the
backbone of the economy. This is because they provide monetary
support for the growth of the economy. The growth of the financial
markets is the barometer of the growth of a country’s economy.
Financial market deals in financial securities (or financial
instruments) and financial services. Financial markets are the centres
or arrangements that provide facilities for buying and selling of
financial claims and services. These are the markets in which money
as well as monetary claims is traded in. Financial markets exist
wherever financial transactions take place. Financial transactions
include issue of equity stock by a company, purchase of bonds in the
secondary market, deposit of money in a bank account, transfer of
funds from a current account to a savings account etc. The
participants in the financial markets are corporations, financial
institutions, individuals and the government. These participants trade
in financial products in these markets. They trade either directly or
through brokers and dealers. In short, financial markets are markets
that deal in financial assets and credit instruments.
III. Functions of Financial Markets: The main functions of
financial markets are outlined as below: 1. To facilitate creation and
allocation of credit and liquidity. 2. To serve as intermediaries for
mobilisation of savings. 3. To help in the process of balanced
economic growth. 4. To provide financial convenience. 5. To provide
information and facilitate transactions at low cost.
IV. Classification of Financial Markets: There are different ways
of classifying financial markets. There are mainly five ways of
classifying financial markets.

1. Classification on the basis of the type of financial claim: On
this basis, financial markets may be classified into debt market and
equity market. Debt market: This isthe financial market for fixed
claims like debt instruments. Equity market: This is the financial
market for residual claims, i.e., equity instruments.
2. Classification on the basis of maturity of claims: On this basis,
financial markets may be classified into money market and capital
market. Money market: A market where short term funds are
borrowed and lend is called money market. It deals in short term
monetary assets with a maturity period of one year or less. Liquid
funds as well as highly liquid securities are traded in the money
market. Examples of money market are Treasury bill market, call
money market, commercial bill market etc. The main participants in
this market are banks, financial institutions and government. In short,
money market is a place where the demand for and supply of short
term funds are met. Capital market: Capital market is the market for
long term funds. This market deals in the long term claims, securities
and stocks with a maturity period of more than one year. It is the
market from where productive capital is raised and made available for
industrial purposes. The stock market, the government bond market
and derivatives market are examples of capital market. In short, the
capital market deals with long term debt and stock.
3. Classification on the basis of seasoning of claim: On this
basis, financial markets are classified into primary market and
secondary market. Primary market: Primary markets are those
markets which deal in the new securities. Therefore, they are also
known as new issue markets. These are markets where securities are
issued for the first time. In other words, these are the markets for the
securities issued directly by the companies. The primary markets
mobilize savings and supply fresh or additional capital to business
units. In short, primary market is a market for raising fresh capital in
the form of shares and debentures.
4. Secondary market: Secondary markets are those markets which
deal in existing securities. Existing securities are those securities that
have already been issued and are already outstanding. Secondary
market consists of stock exchanges. Stock exchanges are self

regulatory bodies under the overall regulatory purview of the Govt.
/SEBI.
5. Classification on the basis of structure or arrangements: On this
basis, financial markets can be classified into organised markets and
unorganized markets. Organised markets: These are financial
markets in which financial transactions take place within the well
established exchanges or in the systematic and orderly structure.
Unorganised markets: These are financial markets in which financial
transactions take place outside the well established exchange or
without systematic and orderly structure or arrangements.
6. Classification on the basis of timing of delivery: On this basis,
financial markets may be classified into cash/spot market and forward
/ future market. Cash / Spot market: This is the market where the
buying and selling of commodities happens or stocks are sold for cash
and delivered immediately after the purchase or sale of commodities
or securities. Forward/Future market: This is the market where
participants buy and sell stocks/commodities, contracts and the
delivery of commodities or securities occurs at a pre-determined time
in future. 6. Other types of financial market: Apart from the above,
there are some other types of financial markets. They are foreign
exchange market and derivatives market. Foreign exchange market:
Foreign exchange market is simply defined as a market in which one
country’s currency is traded for another country’s.
7. currency. It is a market for the purchase and sale of foreign
currencies. Derivatives market: The derivatives are most modern
financial instruments in hedging risk. The individuals and firms who
wish to avoid or reduce risk can deal with the others who are willing
to accept the risk for a price. A common place where such
transactions take place is called the derivative market. It is a market in
which derivatives are traded. In short, it is a market for derivatives.
The important types of derivatives are forwards, futures, options,
swaps, etc.
III. Financial Instruments (Securities) Financial instruments are the
financial assets, securities and claims. They may be viewed as
financial assets and financial liabilities. Financial assets represent
claims for the payment of a sum of money sometime in the future

(repayment of principal) and/or a periodic payment in the form of
interest or dividend. Financial liabilities are the counterparts of
financial assets. They represent promise to pay some portion of
prospective income and wealth to others. Financial assets and
liabilities arise from the basic process of financing. Some of the
financial instruments are tradable/ transferable. Others are non
tradable/non-transferable. Financial assets like deposits with banks,
companies and post offices, insurance policies, NSCs, provident funds
and pension funds are not tradable. Securities (included in financial
assets) like equity shares and debentures, or government securities
and bonds are tradable. Hence they are transferable. In short, financial
instruments are instruments through which a company raises finance.
The financial instruments may be capital market instruments or
money market instruments or hybrid instruments. The financial
instruments that are used for raising capital through the capital market
are known as capital market instruments. These include equity shares,
preference shares, warrants, debentures and bonds. These securities
have a maturity period of more than one year. The financial
instruments that are used for raising and supplying money in a short
period not exceeding one year through money market are called
money market instruments. Examples are treasury bills, commercial
paper, call money, short notice money, certificates of deposits,
commercial bills, money market mutual funds. Hybrid instruments are
those instruments which have both the features of equity and
debenture. Examples are convertible debentures, warrants etc.
Financial instruments may also be classified as cash instruments and
derivative instruments. Cash instruments are financial instruments
whose value is determined directly by markets.
Characteristics of Financial Instruments The important
characteristics of financial instruments may be outlined as below: 1.
Liquidity: Financial instruments provide liquidity. These can be easily
and quickly converted into cash.
8. Marketing: Financial instruments facilitate easy trading on the
market. They have a ready market. 3. Collateral value: Financial
instruments can be pledged for getting loans. 4. Transferability:
Financial instruments can be easily transferred from person to person.

5. Maturity period: The maturity period of financial instruments may
be short term, medium term or long term. 6. Transaction cost:
Financial instruments involve buying and selling cost. The buying and
selling costs are called transaction costs. These are lower. 7. Risk:
Financial instruments carry risk. This is because there is uncertainty
with regard to payment of principal or interest or dividend as the case
may be.
8. Future trading: Financial instruments facilitate future trading so
as to cover risks due to price fluctuations, interest rate fluctuations
etc.
IV. Financial Services The development of a sophisticated and
matured financial system in the country, especially after the early
nineties, led to the emergence of a new sector. This new sector is
known as financial services sector. Its objective is to intermediate and
facilitate financial transactions of individuals and institutional
investors. The financial institutions and financial markets help the
financial system through financial instruments. The financial services
include all activities connected with the transformation of savings into
investment. Important financial services include lease financing, hire
purchase, instalment payment systems, merchant banking, factoring,
forfaiting etc.
Growth and Development of Indian Financial System At the time
of independence in 1947, there was no strong financial institutional
mechanism in the country. The industrial sector had no access to the
savings of the community. The capital market was primitive and shy.
The private and unorganised sector played an important role in the
provision of liquidity. On the whole, there were chaos and confusions
in the financial system. After independence, the government adopted
mixed economic system. A scheme of planned economic development
was evolved in 1951 with a view to achieve the broad economic and
social objective. The government started creating new financial
institutions to supply finance both for agricultural and industrial
development. It also progressively started nationalizing some
important financial institutions so that the flow of finance might be in
the right direction. The following developments took place in the
Indian fina ncial system:

1. Nationalisation of financial institutions: RBI, the leader of the
financial system, was established as a private institution in 1935. It
was nationalized in 1949. This was followed by the nationalisation of
the Imperial bank of India. One of the important mile stone in the
economic growth of India was the nationalisation of 245 life
insurance Corporation in 1956. As a result, Life Insurance
Corporation of India came into existence on 1st September, 1956.
Another important development was the nationalisation of 14 major
commercial banks in 1969. In 1980, 6 more banks were nationalized.
Another landmark was the nationalisation of general insurance
business and setting up of General Insurance Corporation in 1972.
2. Establishment of Development Banks: Another landmark in the
history of development of Indian financial system is the establishment
of new financial institutions to supply institutional credit to industries.
In 1949, RBI undertook a detailed study to find out the need for
specialized institutions. The first development bank was established in
1948. That was Industrial Finance Corporation of India (IFCI). In
1951, Parliament passed State Financial Corporation Act. Under this
Act, State Governments could establish financial corporation’s for
their respective regions. The Industrial Credit and Investment
Corporation of India (ICICI) were set up in 1955. It was supported by
Government of India, World Bank etc. The UTI was established in
1964 as a public sector institution to collect the savings of the people
and make them available for productive ventures. The Industrial
Development Bank of India (IDBI) was established on 1st July 1964
as a wholly owned subsidiary of the RBI. On February 16, 1976, the
IDBI was delinked from RBI. It became an independent financial
institution. It co-ordinates the activities of all other financial
institutions. In 1971, the IDBI and LIC jointly set up the Industrial
Reconstruction Corporation of India with the main objective of
reconstruction and rehabilitation of sick industrial undertakings. The
IRCI was converted into a statutory corporation in March 1985 and
renamed as Industrial Reconstruction Bank of India. Now its new
name is Industrial Investment Bank of India (IIBI). In 1982, the
Export-Import Bank of India (EXIM Bank) was set up to provide
financial assistance to exporters and importers. On April 2, 1990 the

Small Industries Development Bank of India (SIDBI) was set up as a
wholly owned subsidiary of IDBI. The SIDBI has taken over the
responsibility of ad ministrating the Small Industries Development
Fund and the National Equity Fund.
3. Establishment of Institution for Agricultural Development: In
1963, the RBI set up the Agricultural Refinance and Development
Corporation (ARDC) to provide refinance support to banks to finance
major development projects, minor irrigation, farm mechanization,
land development etc. In order to meet credit needs of agriculture and
rural sector, National Bank for Agriculture and Rural Development
(NABARD) was set up in 1982. The main objective of the
establishment of NABARD is to extend short term, medium term and
long term finance to agriculture and allied activities.
4. Establishment of institution for housing finance: The National
Housing Bank (NHB) has been set up in July 1988 as an apex
institution to mobilise resources for the housing sector and to promote
housing finance institutions.
5. Establishment of Stock Holding Corporation of India (SHCIL):
In 1987, another institution, namely, Stock Holding Corporation of
India Ltd. was set up to strengthen the stock and capital markets in
India. Its main objective is to provide quick share transfer facilities,
clearing services, support services etc. to investors.
6. Establishment of mutual funds and venture capital institutions:
Mutual funds refer to the funds raised by financial service companies
by pooling the savings of the public and investing them in a
diversified portfolio. They provide investment avenues for small
investors who cannot participate in the equities of big companies.
Venture capital is a long term risk capital to finance high technology
projects. The IDBI venture capital fund was set up in 1986. The ICICI
and the UTI have jointly set up the Technology Development and
Information Company of India Ltd. in 1988 to provide venture capital.
7. New Economic Policy of 1991: Indian financial system has
undergone massive changes since the announcement of new economic
policy in 1991. Liberalisation, Privatisation and Globalisation has
transformed Indian economy from closed to open economy. The
corporate industrial sector also has undergone changes due to

delicensing of industries, financial sector reforms, capital markets
reforms, disinvestment in public sector undertakings etc. Since 1990s,
Government control over financial institutions has diluted in a phased
manner. Public or development financial institutions have been
converted into companies, allowing them to issue equity/bonds to the
public. Government has allowed private sector to enter into banking
and insurance sector. Foreign companies were also allowed to enter
into insurance sector in India.
Weaknesses of Indian Financial System Even though Indian
financial system is more developed today, it suffers from certain
weaknesses. These may be briefly stated below:
1. Lack of co-ordination among financial institutions: There are a
large number of financial intermediaries. Most of the financial
institutions are owned by the government. At the same time, the
government is also the controlling authority of these institutions. As
there is multiplicity of institutions in the Indian financial system, there
is lack of co-ordination in the working of these institutions.
2. Dominance of development banks in industrial finance: The
industrial financing in India today is largely through the financial
institutions set up by the government. They get most of their funds
from their sponsors. They act as distributive agencies only. Hence,
they fail to mobilise the savings of the public. This stands in the way
of growth of an efficient financial system in the country. 3. Inactive
and erratic capital market: In India, the corporate customers are able
to raise finance through development banks. So, they need not go to
capital market. Moreover, they do not resort to capital market because
it is erratic and inactive. Investors too prefer investments in physical
assets to investments in financial assets. 4. Unhealthy financial
practices: The dominance of development banks has developed
unhealthy financial practices among corporate customers. The
development banks provide most of the funds in the form of term
loans. So there is a predominance of debt in the financial structure of
corporate enterprises. This predominance of debt capital has made the
capital structure of the borrowing enterprises uneven and lopsided.
When these enterprises face financial crisis, the financial institutions

permit a greater use of debt than is warranted. This will make matters
worse.
5. Monopolistic market structures: In India some financial
institutions are so large that they have created a monopolistic market
structures in the financial system. For instance, the entire life
insurance business is in the hands of LIC. The weakness of this large
structure is that it could lead to inefficiency in their working or
mismanagement. Ultimately, it would retard the development of the
financial system of the country itself.
6. Other factors: Apart from the above, there are some other factors
which put obstacles to the growth of Indian financial system.
Examples are: a. Banks and Financial Institutions have high level of
NPA. b. Government burdened with high level of domestic debt. c.
Cooperative banks are labelled with scams. d. Investors confidence
reduced in the public sector undertaking etc., e. Financial illiteracy.
MONEY MARKET Financial Market deals in financial instruments
(securities) and financial services. Financial markets are classified
into two, namely, money market and capital market. Meaning of
Money Market Money market is a segment of financial market. It is a
market for short term funds. It deals with all transactions in short term
securities. These transactions have a maturity period of one year or
less. Examples are bills of exchange, treasury bills etc. These short
term instruments can be converted into money at low transaction cost
and without much loss. Thus, money market is a market for short term
financial securities that are equal to money. According to Crowther,
“Money market is a collective name given to various firms and
institutions that deal in the various grades of near money”. Money
market is not a place. It is an activity. It includes all organizations and
institutions that deal in short term financial instruments. However,
sometimes geographical names are given to the money market
according to the location, e.g. Mumbai Money Market.
Characteristics of Money Market The following are the
characteristics of money market: 1. It is a market for short term
financial assets that are close substitutes of money. 2. It is basically an
over the phone market. 3. It is a wholesale market for short term debt
instruments. 4. It is not a single market but a collection of markets for

several instruments. 5. It facilitates effective implementation of
monetary policy of a central bank of a country. 6. Transactions are
made without the help of brokers. 7. It establishes the link between
the RBI and banks. 8. The players in the money market are RBI,
commercial banks, and companies.
Functions of Money Market Money market performs the following
functions: 1. Facilitating adjustment of liquidity position of
commercial banks, business undertakings and other non-banking
financial institutions. 2. Enabling the central bank to influence and
regulate liquidity in the economy through its intervention in the
market. 3. Providing a reasonable access to users of short term funds
to meet their requirements quickly at reasonable costs. 4. Providing
short term funds to govt. institutions. 5. Enabling businessmen to
invest their temporary surplus funds for short period. 6. Facilitating
flow of funds to the most important uses. 7. Serving as a coordinator
between borrowers and lender of short term funds. 8. Helping in
promoting liquidity and safety of financial assets.
Importance of Money Market A well developed money market is
essential for the development of a country. It supplies short term
funds adequately and quickly to trade and industry. A developed
money market helps the smooth functioning of the financial
system in any economy in the following ways:
1. Development of trade and industry: Money market is an important
source of finance to trade and industry. Money market finances the
working capital requirements of trade and industry through bills,
commercial papers etc. It influences the availability of finance both in
the national and international trade.
2. Development of capital market: Availability funds in the money
market and interest rates in the money market will influence the
resource mobilisation and interest rate in the capital market. Hence,
the development of capital market depends upon the existence of a
developed money market. Money market is also necessary for the
development of foreign exchange market and derivatives market.
3. Helpful to commercial banks: Money market helps commercial
banks for investing their surplus funds in easily realisable assets. The
banks get back the funds quickly in times of need. This facility is

provided by money market. Further, the money market enables
commercial banks to meet the statutory requirements of CRR and
SLR. In short, money market provides a stable source of funds in
addition to deposits.
4. Helpful to central bank: Money market helps the central bank of a
country to effectively implement its monetary policy. Money market
helps the central bank in making the monetary control effective
through indirect methods (repos and open market operations). In
short, a well developed money market helps in the effective
functioning of a central bank.
5. Formulation of suitable monetary policy: Conditions prevailing in
a money market serve as a true indicator of the monetary state of an
economy. Hence it serves as a guide to the Govt. in formulating and
revising the monetary policy. In short, the Govt. can formulate the
monetary policy after taking into consideration the conditions in the
money market.
6. Helpful to Government: A developed money market helps the
Govt. to raise short term funds through the Treasury bill floated in the
market. In the absence of a developed money market, the Govt. would
be forced to issue more currency notes or borrow from the central
bank. This will raise the money supply over and above the needs of
the economy. Hence the general price level will go up (inflationary
trend in the economy). In short, money market is a device to the Govt.
to balance its cash inflows and outflows. Thus, a well developed
money market is essential for economic growth and stability.
Characteristics of a Developed Money Market In every country
some types of money market exists. Some of them are highly
developed while others are not well developed. A well developed and
efficient money market is necessary for the development of any
economy. The following are the characteristics or prerequisites of a
developed and efficient money market: 1. Highly developed
commercial banking system: Commercial banks are the nerve centre
of the whole short term funds. They serve as a vital link between the
central bank and the various segments of the money market. When the
commercial banking system is developed or organized, the money
market will be developed. 2. Presence of a central bank: In a

developed money market, there is always a central bank. The central
bank is necessary for direction and control of money market. Central
bank absorbs surplus cash during off-seasons and provides additional
funds in busy seasons. This is done through open market operations.
Being the bankers’ bank, central bank keeps the reserves of
commercial banks and provides them financial accommodation in
times of need. If the central bank cannot influence the money market
it means the money market is not developed. In short, without the
support of a central bank a money market cannot function. 3.
Existence of sub markets: Money market is a group of various sub
markets. Each sub market deals in instruments of varied maturities.
There should be large number of submarkets. The larger the number
of sub markets, the broader and more developed will be the structure
of money market. Besides, the sub market must be interrelated and
integrated with each other. If there is no co-ordination and integration
among them, different interest rates will prevail in the sub markets. 4.
Availability of credit instruments: The continuous availability of
readily acceptable negotiable securities (near money assets) is
necessary for the existence of a developed money market. In addition
to variety of instruments or securities, there should be a number of
dealers (participants) in the money market to transact in these
securities. It is the dealers in securities who actually infuse life into
the money market.
5. Existence of secondary market: There should be active secondary
market in these credit instruments. The success of money market
always depends on the secondary market. If the secondary market
develops, then there will be active trading of the instruments.
6. Availability of ample resources: There must be availability of
sufficient funds to finance transactions in the sub markets. These
funds may come from within the country and outside the country.
Under developed money markets do not have ample funds. Thus
availability of sufficient funds is essential for the smooth and efficient
functioning of the money market.
7. Demand and supply of funds: Money market should have a large
demand and supply of funds. This depends upon the number of

participants and also the Govt. policies in encouraging the
investments in various sectors and monetary policy of RBI.
8. Other factors: There are some other factors that also contribute to
the development of a money market. These factors include industrial
development, volume of international trade, political stability, trade
cycles, foreign investment, price stabilisation etc.
Components / Constituents / Composition of Money Market
(Structure of Money Market)
Money market consists of a number of sub markets. All submarkets
collectively constitute the money market. Each sub market deals in a
particular financial instrument. The main components or constituents
or sub markets of money markets are as follows:
1.Call money market 2. Commercial bill market 3. Treasury bill
markets 4. Certificates of deposits market 5. Commercial paper
market 6. Acceptance market 7. Collateral loan market
I. Call Money Market Call money is required mostly by banks.
Commercial banks borrow money without collateral from other banks
to maintain a minimum cash balance known as cash reserve ratio
(CRR). This interbank borrowing has led to the development of the
call money market. Call money market is the market for very short
period loans. If money is lent for a day, it is called call money. If
money is lent for a period of more than one day and upto 14 days is
called short notice money. Thus call money market refers to a market
where the maturity of loans varies between 1 day to 14 days. In the
call money market, surplus funds of financial institutions, and banks
are traded. There is no demand for collateral security against call
money. In India call money markets are mainly located in big
industrial and commercial centres like Mumbai, Kolkata, Chennai,
Delhi and Ahmadabad.
Participants or Players in the Call Money Market
1. Scheduled commercial banks and RBI 2. Non-Scheduled
commercial banks 3. Co-operative banks 4. Foreign banks 5. Discount
and Finance House of India 6. Primary dealers
The above players are permitted to operate both as lenders and
borrowers. (1) LIC (2) UTI (3) GIC (4) IDBI (5) NABARD (6)

Specific mutual funds, etc. The above participants are permitted
to operate as lenders
2. Commercial Bill Market Commercial bill market is another
segment of money market. It is a market in which commercial bills
(short term) are bought and sold. Commercial bills are important
instruments. They are widely used in both domestic and foreign trade
to discharge the business obligations (or to settle business
obligations). Discounting is the main process in this market. Hence
commercial bill market is also known as discount market. There are
specialized institutions known as discount houses for discounting
commercial bills accepted by reputed acceptance houses. RBI has
permitted the financial institutions, mutual funds, commercial banks
and cooperative banks to enter in the commercial bill market.
3. Treasury Bills Market Treasury bill market is a market which
deals in treasury bills. In this market, treasury bills are bought and
sold. Treasury bill is an important instrument of short term borrowing
by the Govt. These are the promissory notes or a kind of finance bill
issued by the Govt. for a fixed period not extending beyond one year.
Treasury bill is used by the Govt. to raise short term funds for
meeting temporary Govt. deficits. Thus it represents short term
borrowings of the Govt.
Advantages or Importance of Treasure Bill Market Advantages to
the Issuer / Govt. 1. The Govt. can raise short term funds for meeting
temporary budget deficit.2. The Govt. can absorb excess liquidity in
the economy through the issue of T- bills in the market. 3. It does not
lead to inflationary pressure. Advantages for the Purchaser/ Investor
1. It is a ready market for purchasers or investors
4.Certificates of Deposits Market CD market is a market which
deals in CDs. CDs are short term deposit instruments to raise large
sums of money. These are short term deposits which are transferable
from one party to another. Banks and financial institutions are major
issuers of CD. These are short term negotiable instruments.
Advantages of CD Market 1. It enables the depositors to earn higher
return on their short term surplus. 2. The market provides maximum
liquidity. 3. The bank can raise money in times of need. This will
improve their lending capacity. 4. The market provides an opportunity

for banks to invest surplus funds. 5. The transaction cost of CDs is
lower.
5. Commercial Paper Market Commercial Paper Market is another
segment of money market. It is a market which deals in commercial
papers. Commercial papers are unsecured short term promissory notes
issued by reputed, well established and big companies having high
credit rating. These are issued at a discount. Commercial papers can
now be issued by primary dealers and all India financial institutions.
They can be issued to (or purchased by) individua als, banks,
companies and other registered Indian corporate bodies. (Investors in
CP) Role of RBI in the Commercial Paper Market The Working
Group on Money Market (Vaghul Committee) in 1987 suggested the
introduction of the commercial Paper (CP) in India. As per the
recommendation of the committee, the RBI introduced commercial
papers in January 1990. The Committee suggested the following: (a)
CP should be issued to investors directly or through bankers. (b) The
CP issuing company must have a net worth of not less then Rs. 5
crores. (c) The issuing company’s shares must be listed in the stock
exchange.
Acceptance Market Acceptance Market is another component of
money market. It is a market for banker’s acceptance. The acceptance
arises on account of both home and foreign trade. Bankers acceptance
is a draft drawn by a business firm upon a bank and accepted by that
bank. It is required to pay to the order of a particular party or to the
bearer, a certain specific amount at a specific date in future. It is
commonly used to settle payments in international trade. Thus
acceptance market is a market where the bankers’ acceptances are
easily sold and discounted.
7. Collateral Loan Market Collateral loan market is another
important sector of the money market. The collateral loan market is a
market which deals with collateral loans. Collateral means anything
pledged as security for repayment of a loan. Thus collateral loans are
loans backed by collateral securities such as stock, bonds etc. The
collateral loans are given for a few months. The collateral security is
returned to the borrower when the loan is repaid. When the borrower
is not able to repay the loan, the collateral becomes the property of the

lender. The borrowers are generally the dealers in stocks and shares.
Money Market Instruments Money market is involved in buying and
selling of short term instruments. It is through these instruments, the
players or participants borrow and lend money in the money market.
There are various instruments available in the money market.
The important money market instruments are:- 1. Call and short
notice money 2. Commercial bills 3. Treasury bills 4. Certificate of
deposits Commercial papers 6. Repurchase agreements 7. Money
market mutual funds. 8. ADR/GDR
These instruments are issued for short period. These are interest
bearing securities. These instruments may be discussed in detail.
Call and Short Notice Money These are short term loans. Their
maturity varies between one day to fourteen days. If money is
borrowed or lent for a day it is called call money or overnight money.
When money is borrowed or lent for more than a day and up to
fourteen days, it is called short notice money. Surplus funds of the
commercial banks and other institutions are usually given as call
money. Banks are the borrowers as well as the lenders for the call
money. Banks borrow call funds for a short period to meet the cash
reserve ratio (CRR) requirements. Banks repay the call fund back
once the requirements have been met. The interest rate paid on call
loans is known as the call rate. It is a highly volatile rate. It varies
from day to day, hour to hour, and sometimes even minute to minute.
Commercial Bills When goods are sold on credit, the seller draws a
bill of exchange on the buyer for the amount due. The buyer accepts it
immediately. This means he agrees to pay the amount mentioned
therein after a certain specified date. After accepting the bill, the
buyer returns it to the seller. This bill is called trade bill. The seller
may either retain the bill till maturity or due date or get it discounted
from some banker and get immediate cash. When trade bills are
accepted by commercial banks, they are called commercial bills. The
bank discounts this bill by deducting a certain amount (discount) and
balance is paid.
A bill of exchange contains a written order from the creditor (seller)
to the debtor (buyer) to pay a certain sum, to a certain person after a
certain period. According to Negotiable instruments Act, 1881, a bill

of exchange is ‘an instrument in writing containing an unconditional
order, signed by the maker, directing a certain person to pay a certain
sum of money only to, or to the order of a certain person or to the
bearer of the instrument’.
Types of Bills Many types of bills are in circulation in a bill market.
They may be broadly classified as follows:
1. Demand Bills and Time Bills :- Demand bill is payable on
demand. It is payable immediately on presentation or at sight to the
drawing. Demand bill is also known as sight bill. Time bill is payable
at a specified future date. Time bill is also known as usance bill.
2. Clean Bills and Documentary Bills: When bills have to be
accompanied by documents of title to goods such as railway receipts,
bill of lading etc. the bills are called documentary bills. When bills are
drawn without accompanying any document, they are called clean
bills. In such a case, documents will be directly sent to the drawee.
3. Inland and Foreign Bills :- Inland bills are bills drawn upon a
person resident in India and are payable in India. Foreign bills are
bills drawn outside India and they may be payable either in India or
outside India.
Accommodation Bills and Supply Bills :- In case of accommodation
bills, two parties draw bills on each other purely for the purpose of
mutual financial accommodation. These bills are then discounted with
the bankers and the proceeds are shared among themselves. On the
due dates, the parties make payment to the bank. Accommodation
bills are also known as ‘wind bills’ or ‘kite bills’. Supply bills are
those drawn by suppliers or contactors on the Govt. departments for
the goods supplied to them. These bills are not considered as
negotiable instruments.
1.Treasury Bills Treasury bills are short term instruments issued by
RBI on behalf of Govt. These are short term credit instruments for a
period ranging from 91 to 364. These are negotiable instruments.
Hence, these are freely transferable. These are issued at a discount.
These are repaid at par on maturity. These are considered as safe
investment. Thus treasury bills are credit instruments used by the
Govt. to raise short term funds to meet the budgetary deficit. Treasury
bills are popularly called T- bills. The difference between the amount

paid by the tenderer at the time of purchase (which is less than the
face value), and the amount received on maturity represents the
interest amount on T-bills and is known as the discount.
2.Certificate of Deposits (CDs) With a view to give investor’s
greater flexibility in the development of their short term surplus
funds, RBI permitted banks to issue Certificate of Deposit. CDs were
introduced in June 1989. CD is a certificate in the form of promissory
note issued by banks against the short term deposits of companies and
institutions, received by the bank. Simply stated, it is a time deposit of
specific maturity and is easily transferable. It is a document of title to
a time deposit. It is issued as a bearer instrument and is negotiable in
the market. It is payable on a fixed date. It has a maturity period
ranging from three to twelve months. It is issued at a discount rate
varying between 13% to 18%. The discount rate is determined by the
issuing bank and the market. All scheduled banks except Regional
Rural Banks and scheduled co-operative banks are eligible to issue
CDs to the extent of 7% of deposits. It can be issued to individuals,
corporations, companies, trusts, funds and associations. CDs are
issued by banks during period of tight liquidity, at relatively high
interest rate. Banks rely on this source when the deposit growth is low
but credit demand is high. They can be issued to individuals,
companies, trusts, funds, associates, and others.
3.Commercial Papers (CPs) Commercial paper was introduced into
the market in 1989-90. It is a finance paper like Treasury bill. It is an
unsecured, negotiable promissory note. It has a fixed maturity period
ranging from three to six months. It is generally issued by leading,
nationally reputed credit worthy and highly rated corporations. It is
quite safe and highly liquid. It is issued in bearer form and on
discount. It is also known as industrial paper or corporate paper. CPs
can be issued in multiples of Rs. 5 lakhs subject to the minimum issue
size of Rs. 50 lakhs. Thus a CP is an unsecured short term promissory
note issued by leading, creditworthy and highly rated corporates to
meet their working capital requirements. In short, a CP is a short term
unsecured promissory note issued by financially strong companies.
Money Market Mutual Funds (MMMFs) Money Market Mutual
Funds mobilise money from the general public. The money collected

will be invested in money market instruments. The investors get a
higher return. They are more liquid as compared to other investment
alternatives. The MMMFs were originated in the US in 1972. In India
the first MMMF was set up by Kothari Pioneer in 1997. But this did
not succeed. Advantages of MMMFs 1. These enable small investors
to participate in the money market. 2. The investors get higher return.
3. These are highly liquid. 4. These facilitate the development of
money market. Disadvantage of MMMFs 1. Heavy stamp duty. 2.
Higher flotation cost. 3. Lack of investors education.
1.American Depository Receipt and Global Depository Receipt:
ADRs are instruments in the nature of depository receipt and
certificate. These instruments are negotiable and represent publicly
traded, local currency equity shares issued by non - American
company. For example, an NRI can invest in Indian Company’s
shares without bothering dollar conversion and other exchange
formalities. If the facilities extended globally, these instruments are
called GDR. ADR are listed in American Stock exchanges and GDR
are listed in other than American Stock exchanges, say Landon,
Luxembourg, Tokyo.
Structure of the Indian Money Market In the Indian money market
RBI occupies a key role. It is the nerve centre of the monetary system
of our country. It is the leader of the Indian money market. The Indian
money market is highly disintegrated and unorganized. The Indian
money market can be divided into two sectors - unorganized and
organised. In between these two, there exists the co-operative sector.
It can be included in the organised sector. The organised sector
comprises of RBI, SBI group of banks, public sector banks, private
sector banks, development banks and other financial institutions. The
unorganised sector comprises of indigenous bankers, money lenders,
chit funds etc. These are outside the control of RBI. This is the reason
why Indian money market remains underdeveloped.
Features or Defects of the Indian Money Market The features or
defects of the Indian money market are as follows:
1. Existence of unorganised segment: The most important defect of
the Indian money market is the existence of unorganised segment.
The unorganised segment comprises of indigenous bankers,

moneylenders etc. This unorganised sector does not follow the rules
and regulations of the RBI. Besides, a higher rate of interest prevails
in the unorganised market.
2. Lack of integration: Another important drawback of the Indian
money market is that the money market is divided into different
sections. Unfortunately these sections are loosely connected to each
other. There is no co-ordination between the organised and
unorganised sectors. With the setting up of the RBI and the passing of
the Banking Regulations Act, the conditions have improved.
3. Disparities in interest rates: Interest rates in different money
markets and in different segments of money market still differ. Too
many interest rates are prevailing in the market. For example,
borrowing rates of Govt. lending rate of commercial banks, the rates
of co-operative banks and rates of financial institutions. This disparity
in interest rates is due to lack of mobility of funds from one segment
to another.
4. Seasonal diversity of money market: The demand for money in
Indian money market is of seasonal in nature. During the busy season
from November to June, money is needed for financing the marketing
of agricultural products, seasonal industries such as sugar, jaguar, etc.
From July to October the demand for money is low. As a result, the
money rates fluctuate from one period to another.
5. Absence of bill market: The bill market in India is not well
developed. There is a great paucity of sound commercial bills of
exchange in our country. As a matter of habit, Indian traders resort to
hundies rather than properly drawn bill of exchange. 6. Limited
instruments: The supply of short term instruments like commercial
bills, treasury bills etc. are very limited and inadequate.
7. Limited number of participants: The participants in the Indian
money market are limited. Entry in the money market is tightly
regulated.
8. Restricted secondary mark et: Secondary market for money
market instruments is mainly restricted to rediscounting of
commercial bills and treasury bills.
Players or Participants in the Indian Money Market The following
are the players in the Indian money market: 1. Govt. 2. RBI 3.

Commercial banks 4. Financial institutions like IFCI, IDBI, ICICI,
SIDBI, UTI, LIC
Discount and Finance House of India. 6. Brokers 7. Mutual funds 8.
Public sector undertakings 9. Corporate units Recent Developments in
the Indians Money Market
The recent developments in the Indian money market may be
briefly explained as below:
1. Integration of unorganised sector with the organised sector :
RBI has taken many steps to bring the institutions in the unorganised
sector within its control and regulation. These institutions are now
slowly coming under the organised sector. They started availing of the
rediscounting facilities from the RBI.
2. Widening of call money market: In recent years, many steps have
been taken to widen the call money market. The number of
participants in the call money market is increasing. LIC, GIC, IDBI,
UTI and specialised mutual funds have been permitted to enter into
this market as lenders only. The DFHI and STCI have been permitted
to operate both as lenders and borrowers.
3. Introduction of innovative instruments: New financial
instruments have been introduced in the money market. On the
recommendation of the Chakkraborty Committee, the RBI introduced
192 days T-bills since 1986.A new instrument in the form of 364 days
T-bills was introduced at the end of April 1992. Again, new
instruments such as CDs, CPs, and interbank participation certificates
have been introduced. Necessary guidelines also have been issued for
the operation of these instruments.
4. Introduction of negotiable dealing system : As negotiable dealing
system has been introduced with a view to facilitating electronic
bidding in auctions and secondary market transactions in Govt.
securities and dissemination of information.
5. Offering of market rates of interest: In order to popularise money
market instruments, the ceiling on interest rate has been abolished.
Call money rate, bill discounting rate, inter bank rate etc. have been
freed from May 1, 1989. Thus, today Indian money market offers full
scope for the play of market forces in determining the rates of interest.

6. Satellite system dealership: The satellite system dealership was
launched in 1996 to serve as a second tier to primary dealers in
retailing of Govt. securities RBI has decided to allow players such as
provident funds, trusts to participate in government bond auctions, on
a non-competitive basis.
7. Promotion of bill culture: All attempts are being taken to
discourage cash credit and overdraft system of financing and to
popularise bill financing. Exemption from stamp duty is given on
rediscounting of derivative usance promissory notes arising out of
genuine trade bill transactions. This is done to promote bill culture in
the country.
Introduction of money market mutual funds: Recently certain
private sector mutual funds and subsidiaries of commercial banks
have been permitted to deal in money market instrument. This has
been done with a view to expand the money market and also to
develop secondary market for money market instruments.
Setting up of credit rating agencies: Recently some credit rating
agencies have been established. The important agencies are the Credit
Rating Information Services of India Ltd (CRISIL), Investment
Information and Credit Rating Agency of India (IICRA) and, Credit
Analysis and Research Ltd. (CARE). These have been set up to
provide credit information through financial analysis of leading
companies and industrial sectors.
Adoption of suitable monetary policy: In recent years the RBI is
adopting a more realistic and appropriate monetary and credit
policies. The main objective is to increase the availability of resources
in the money market and make the money market more active.
Discount and Finance House of India The DFHI was set up in April
1988 as a specialised money market institution. It was set up as for
the recommendations of the Vaghal Committee. DFHI was given the
specific task of widening and deepening the money market. The DFHI
was set up jointly by the RBI, public sector banks and financial
institutions.
Main Objectives of DFHI 1. To provide liquidity to money market
instruments. 2. To provide safe and risk free short term investment
avenues to institutions. 3. To facilitate money market transactions of

small and medium sized institutions that are not regular participants in
the market. 4. To integrate the various segments of the money market.
5. To develop a secondary market for money market instruments.
Meaning and Definition of Capital Market Capital market simply
refers to a market for long term funds. It is a market for buying and
selling of equity, debt and other securities. Generally, it deals with
long term securities that have a maturity period of above one year.
Capital market is a vehicle through which long term finance is
channelized for the various needs of industry, commerce, govt. and
local authorities. According to W.H. Husband and J.C. Dockerbay,
“the capital market is used to designate activities in long term credit,
which is characterised mainly by securities of investment type”. Thus,
capital market may be defined as an organized mechanism for the
effective and smooth transfer of money capital or financial resources
from the investors to the entrepreneurs.
Characteristics of Capital Market 1. It is a vehicle through which
capital flows from the investors to borrowers. 2. It generally deals
with long term securities. 3. All operations in the new issues and
existing securities occur in the capital market. 4. It deals in many
types of financial instruments. These include equity shares, preference
shares, debentures, bonds, etc. These are known as securities. It is for
this reason that capital market is known as ‘Securities Market’. 5. It
functions through a number of intermediaries such as banks, merchant
bankers, brokers, underwriters, mutual funds etc. They serve as links
between investors and borrowers. 6. The constituents (players) in the
capital market include individuals and institutions. They include
individual investors, investment and trust companies, banks, stock
exchanges, specialized financial institutions etc.
Functions of a Capital Market The functions of an efficient capital
market are as follows: 1. Mobilise long term savings for financing
long term investments. 2. Provide risk capital in the form of equity or
quasi-equity to entrepreneurs. 3. Provide liquidity with a mechanism
enabling the investor to sell financial assets. 4. Improve the efficiency
of capital allocation through a competitive pricing mechanism. 5.
Disseminate information efficiently for enabling participants to
develop an informed opinion about investment, disinvestment,

reinvestment etc. 6. Enable quick valuation of instruments – both
equity and debt. 7. Provide insurance against market risk through
derivative trading and default risk through investment protection fund.
8. Provide operational efficiency through: (a) simplified transaction
procedures, (b) lowering settlement times, and (c) lowering
transaction costs. 9. Develop integration among: (a) debt and financial
sectors, (b) equity and debt instruments, (c) long term and short term
funds.
Importance of Capital Market The importance of capital market is
outlined as below: 1. Mobilisation of savings: Capital market helps in
mobilizing the savings of the country. It gives an opportunity to the
individual investors to employ their savings in more productive
channels. 2. Capital formation: Large amount is required to invest in
infrastructural foundation. Such a large amount cannot be collected
from one individual or few individuals. Capital market provides an
opportunity to collect funds from a large number of people who have
investible surplus. In short, capital market plays a vital role in capital
formation at a higher rate. 3. Economic development: With the help of
capital market, idle funds of the savers are channelized to the
productive sectors. In this way, capital market helps in the rapid
industrialization and economic development of a country. 4.
Integrates different parts of the financial system: The different
components of the financial system includes new issue market, money
market, stock exchange etc. It is the capital market which helps to
establish a close contact among different parts of the financial system.
This is essential for the growth of an economy.
Components of Capital Market There are four main components of
capital market. They are: (a) Primary market, (b) Government
Securities Market, (c) Financial Institutions, and (d) Secondary
Market
These components of capital market may be discussed in detail in the
following pages:
Primary Market /New Issue Market (NIM) Every company needs
funds. Funds may be required for short term or long term. Short term
requirements of funds can be met through banks, lenders, institutions
etc. When a company wishes to raise long term capital, it goes to the

primary market. Primary market is an important constituent of a
capital market. In the primary market the security is purchased
directly from the issuer.
Meaning of Primary Market The primary market is a market for
new issues. It is also called new issue market. It is a market for fresh
capital. It deals with the new securities which were not previously
available to the investing public. Corporate enterprises and Govt.
raises long term funds from the primary market by issuing financial
securities. Both the new companies and the existing companies can
issue new securities on the primary market. It also covers raising of
fresh capital by government or its agencies. The primary market
comprises of all institutions dealing in fresh securities. These
securities may be in the form of equity shares, preference shares,
debentures, right issues, deposits etc.
Functions of Primary Market
The main function of a primary market can be divided into three
service functions. They are: origination, underwriting and distribution.
1. Origination: Origination refers to the work of investigation,
analysis and processing of new project proposals. Origination begins
before an issue is actually floated in the market. The function of
origination is done by merchant bankers who may be commercial
banks, all India financial institutions or private firms.
2. Underwriting: When a company issues shares to the public it is
not sure that the whole shares will be subscribed by the public.
Therefore, in order to ensure the full subscription of shares (or at least
90%) the company may underwrite its shares or debentures. The act
of ensuring the sale of shares or debentures of a company even before
offering to the public is called underwriting. It is a contract between a
company and an underwriter (individual or firm of individuals) by
which agrees to undertake that part of shares or debentures which has
not been subscribed by the public. The firms or persons who are
engaged in underwriting are called underwriters.
3. Distribution: This is the function of sale of securities to ultimate
investors. This service is performed by brokers and agents. They
maintain a direct and r Financial Institutions Financial institutions are
the most active constituent of the Indian capital market. There are

special financial institutions which provide medium and long term
loans to big business houses. Such institutions help in promoting new
companies, expansion and development of existing companies etc.
The main special financial institutions of the Indian capital are IDBI,
IFCI, ICICI, UTI, LIC, NIDC, SFCs etc.
New Financial Instruments in the Capital Market With the
evolution of the capital market, new financial instruments are being
introduced to suit the requirements of the market. Some of the new
financial instruments introduced in recent years may be briefly
explained as below:
1. Floating rate bonds: The interest rate on these bonds is not fixed.
It is a concept which has been introduced primarily to take care of the
falling market or to provide a cushion in times of falling interest rates
in the economy. It helps the issuer to hedge the loss arising due to
interest rate fluctuations. Thus there is a provision to reduce interest
risk and assure minimum interest on the investment. In India, SBI was
the first to introduce FRB for retail investors.
2. Zero interest bonds: These carry no periodic interest payment.
These are sold at a huge discount. These can be converted into equity
shares or non-convertible debentures
3. Deep discount bonds: These bonds are sold at a large discount
while issuing them. These are zero coupon bonds whose maturity is
very high (say, 15 years). There is no interest payment. IDBI was the
first financial institution to offer DDBs in 1992.
4. Auction related debentures: Regular contact with the ultimate
investors. These are a hybrid of CPs and debentures. These are
secured, redeemable, non-convertible instrument. The interest on
them is determined by the market. These are placed privately with
bids. ANZ Grindlays designed this new instrument for Ashok Leyland
Finance.
Secondary Market The investors want liquidity for their
investments. When they need cash, they should be able to sell the
securities they hold. Similarly there are others who want to invest in
new securities. There should be a place where securities of different
companies can be bought and sold. Secondary market provides such a
place. Meaning of Secondary Market Secondary market is a market

for old issues. It deals with the buying and selling existing securities
i.e. securities already issued. In other words, securities already issued
in the primary market are traded in the secondary market. Secondary
market is also known as stock market. The secondary market operates
through ‘stock exchanges’.
Stock Exchange In India the first organized stock exchange was
Bombay Stock Exchange. It was started in 1877. Later on, the
Ahmadabad Stock Exchange and Calcutta Stock Exchange were
started in 1894 and 1908 respectively. At present there are 24 stock
exchanges in India. In Europe, stock exchanges are often called
bourses. Meaning and Definition of Stock Exchange/ Security
Exchange It is an organized market for the purchase and sale of
securities of joint stock companies, government and semi- govt.
bodies. It is the centre where shares, debentures and govt. securities
are bought and sold.
Economic Functions of Stock Exchange The stock exchange
performs the following essential economic functions:
1. Ensures liquidity to capital: The stock exchange provides a place
where shares and stocks are converted into cash. People with surplus
cash can invest in securities (by buying securities) and people with
deficit cash can sell their securities to convert them into cash.
2. Continuous market for securities: It provides a continuous and
ready market for buying and selling securities. It provides a ready
market for those who wish to buy and sell securities
3. Mobilisation of savings: It helps in mobilizing savings and surplus
funds of individuals, firms and other institutions. It directs the flow of
capital in the most profitable channel. 4. Capital formation: The stock
exchange publishes the correct prices of various securities. Thus the
people will invest in those securities which yield higher returns. It
promotes the habit of saving and investment among the public. In this
way the stock exchange facilitates the capital formation .
Role of Financial Institution in the Financial System o Financial
institutions are financial intermediaries. o They provide the means and
mechanism of transferring the resources from those whose income is
more than expenditure to those who need these resources for
productive purposes. o The savings of the savers will reach the

borrowers through the financial intermediaries in the form of financial
instruments such as shares, stocks, debentures, deposits, loans etc.
Thus, they play the role of intermediate between the savings and
investments. o They provide safety, liquidity and ensure return for
savings. o Financial institutions develop the saving habit among the
people. o They mobilise huge amount of savings for the industrial
development as a productive capital. The financial institutions supply
capital to the small, medium and large scale industries in India in the
form of capital, venture capital, and services to promote the industrial
growth in India.
Banking Financial Institutions Banking financial institutions are
those financial institutions which carry on banking activities. Banking
business is carried on by these institutions after obtaining an approval
under Banking Regulation Act, 1949 and RBI. It accepts deposits
from the public. It lends money to people engaged in commerce,
industry and agriculture. It finances foreign trade and deals in foreign
exchange. It provides short, medium and long term credit. It acts as an
agent of RBI. It deals in stocks and shares, trusteeship, executorships
etc. In short, the bank can be aptly described, as ‘department store of
finance’ because it engages itself in every form of banking business.
Commercial banks A Bank is a financial Institution whose main
business is accepting deposits and lending loans. A Banker is a dealer
of money and credit. Banking is an evolutionary concept i.e.
expanding its network of operations. According to Banking
revolutions Act 1949, the word BANKING has been defined as
“Accepting for the purpose of lending and investment of deposits of
money from the public repayable on demand or otherwise”.
Non-Banking Financial Institutions These are the financial
institutions which are not permitted to carry on the banking activities
as per Banking Regulation Act, 1949 and RBI regulations. These
institutions have been established by special legislations to provide
finance to specified categories of industries or persons.
Classification of Non-Banking Financial Institutions Non-banking
financial institutions can be classified to three. They are : 1. All-India
Financial Institutions or All-India Development Banks or Specialised

Financial Institutions 2. State Level Financial Institutions 3.
Investment Institutions
Development banks are expected to act as catalysts in performing
developmental and promotional functions. As regards banking
obligations, it is supposed to undertake the primary task of providing
financial assistance in different forms. These are something more than
pure financial institutions. Development banks are viewed as financial
intermediary supplying medium and long term funds to bankable
economic development projects and providing related services. They
are expected to mobilise large capital from other sources.
Accordingly, the task of economic transformation and rapid
industrialisation can best be handled only through development banks
rather than through the normal process of governmental machinery.
Finance Corporation of India (IFCI) The IFCI is the first
Development Financial Institution in India. It is a pioneer in
development banking in India. It was established in 1948 under an
Act of Parliament. The main objective of IFCI is to render financial
assistance to large scale industrial units, particularly at a time when
the ordinary banks are not forth coming to assist these concerns. Its
activities include project financing, financial services, merchant
banking and investment. Till 1993, IFCI continued to be
Developmental Financial Institution. After 1993, it was changed from
a statutory corporation to a company under the Indian Companies Act,
1956 and was named as IFCI Ltd with effect from October 1999.
Industrial Development Bank of India (IDBI) The IDBI was
established on July 1, 1964 under an Act of Parliament. It was set up
as the central co-ordinating agency, leader of development banks and
principal financing institution for industrial finance in the country.
Originally, IDBI was a wholly owned subsidiary of RBI. But it was
delinked from RBI w.e.f. Feb. 16, 1976. IDBI is an apex institution to
co-ordinate, supplement and integrate the activities of all existing
specialised financial institutions. It is a refinancing and re-discounting
institution operating in the capital market to refinance term loans and
export credits. It is in charge of conducting techno-economic studies.
It was expected to fulfil the needs of rapid industrialisation.

Industrial Credit and Investment Corporation of India (ICICI)
ICICI was set up in 1955 as a public limited company. It was to be a
private sector development bank in so far as there was no
participation by the Government in its share capital. It is a diversified
long term financial institution and provides a comprehensive range of
financial products and services including project and equipment
financing, underwriting and direct subscription to capital issues,
leasing, deferred credit, trusteeship and custodial services, advisory
services and business consultancy.
Investment Institutions The important investment institutions are: 1.
Unit Trust of India (UTI) 2. Life Insurance Corporation of India (LIC)
3. General Insurance Corporation of India (GIC)
1.Life Insurance Corporation of India (LIC) The Life Insurance
Corporation of India was set up under the LIC Act, 1956 under which
the life insurance was nationalised. As a result, business of 243
insurance companies was taken over by LIC on 1-9-1956. It is
basically an investment institution, in as much as the funds of policy
holders are invested and dispersed over different classes of securities,
industries and regions, to safeguard their maximum interest on long
term basis. Life Insurance Corporation of India is required to invest
not less than 75% of its funds in Central and State Government
securities, the government guaranteed marketable securities and in the
socially-oriented sectors. At present, it is the largest institutional
investor. It provides long term finance to industries. Besides, it
extends resource support to other term lending institutions by way of
subscription to their shares and bonds and also by way of term loans.
2.General Insurance Corporation of India (GIC) General
insurance industry in India was nationalised and a government
company known as General Insurance Corporation of India was
formed by the central government in November, 1972. General
insurance companies have willingly catered to these increasing
demands and have offered a plethora of insurance covers that almost
cover anything under the sun. Any insurance other than ‘Life
Insurance’ falls under the classification of General Insurance.
1.Unit Trust of India (UTI) The Unit Trust of India was set up in
February 1964 under the Unit Trust of India Act of 1963, in the public

sector. It plays an important role in mobilising savings of investors
through sale of units and channelizing them into corporate
investments. Over the years, it has introduced a variety of growth
schemes to meet needs of diverse section of investors. After an
amendment to its Act in April 1986, Unit Trust of India has started
extending assistance to corporate sector by way of term loans, bills
rediscounting, equipment leasing and hire purchase facilities.
Non-Banking Financial Corporation (NBFC) Financial
intermediaries are that institution which link lenders and borrows.
The process of transferring saving from savers to investors is known
as financial intermediation. Commercial banks and cooperative credit
societies are called “finance corporations”, or “finance companies”.
These finance companies with very little capital have been mobilizing
deposits by offering attractive interest rates and incentives and
advance loans to wholesale and retail traders, small industries and
self-employed persons. They grant unsecured loans at very rates of
interest. These are non-banking companies performing the functions
of financial intermediaries. They cannot be called banks. A Non-
Banking Financial Company (NBFC) is a company registered under
the Companies Act, 1956 and is engaged in the business of loans and
advances, acquisition of shares, securities, leasing, hire-purchase,
insurance business, and chit business.
1.Difference between banks & Non-Banking Financial
Corporations: Non-Banking Financial Corporations are doing
functions similar to that of banks; however there are a few
differences: 1) A Non-Banking Financial Corporations cannot accept
demand deposits, 2) It is not a part of the payment and settlement
system and as such cannot issue cheques to its customers, 3) Deposit
insurance facility of DICGC is not available for Non-Banking
Financial Corporations depositors unlike in case of banks.

MBA 2018
SUBJECT NAME:
ENTREPRENEURSHIP AND PROJECT
MANAGEMENT

MBA207-18 Entrepreneurship Development and Project Management
Unit I
Introduction to Entrepreneur: Concept, Characteristics, functions of an
entrepreneur, Entrepreneur Vs Manager, Types of entrepreneur, Entrepreneurial
Mind Set, Key attributes of an entrepreneur, desirable and acquirable traits and
behaviours, Readiness of the entrepreneur: Right age, right time and right
conditions, Myths and Realities of entrepreneurship. Entrepreneurship and
Intrapreneurship: Similarities and variance, Developing Corporate
Entrepreneurship. Women entrepreneurs:-Meaning, role, problems for women
entrepreneurs, Rural entrepreneurship, social entrepreneurship,
Entrepreneurship Development, Entrepreneurial support systems and role of
government in Entrepreneurship Development..
Unit II
Entrepreneurial Motivation: Concept and Theories, Entrepreneurial Strategy:
Generating and Exploiting New Entry Opportunities, Generation of new Entry
Opportunity, entry Strategy, Risk reduction strategies for New Entry
Exploitation Creativity and Business Idea Generation: Concept of creativity,
ideas from trend analysis, sources of new ideas, Methods of generating new
ideas, Creative problem solving, creativity and entrepreneurship.
Entrepreneurial Innovation: Concept and types, Opportunity Recognition and
opportunity assessment plan, product planning and development process..
Unit III
Protecting Ideas and Legal issues for the entrepreneur. Concept of IPR, Patents,
Trademarks, Copyrights, Licensing, Product Safety, Other Legal Issues in
Setting Up An Organisation. Business Plan Creating and Starting the Venture:
Concept of Business Plan, Scope and Value, Writing the business plan, Using
and implementing business plan. Succession Planning and Strategies for
Harvesting and Ending Venture: Exit Strategy , succession of Business, Selling
off, bankruptcy Reasons of failure of business plan, Reasons for the failure of
entrepreneurial ventures.
Unit IV
Project Management: Concept, facets and Key Issues of project management.
Generation and screening of project ideas, Project Analysis: Market and demand
analysis, Technical analysis, Financial estimates and projection, Project
Selection: Investment criteria, Risk analysis, Social Cost Benefit analysis.
Project Financing: Financing of projects, Concept of Venture Capital in detail,
Difference between Venture Capital and Private Equity. Project
Implementation: Project planning and control, Network techniques for project
management: PERT and CPM Models, Project Review: Post Audit and
Administrative Aspects.

Unit 1
Entrepreneurship is the act of setting out on your own and starting a
business instead of working for someone else in his business. While
entrepreneurs must deal with a larger number of obstacles and fears
than hourly or salaried employees, the payoff may be far greater as
well.
Interest and Vision
The first factor for entrepreneurial success is interest. Since
entrepreneurship pays off according to performance rather than time
spent on a particular effort, an entrepreneur must work in an area that
interests her. Otherwise, she will not be able to maintain a high level
of work ethic, and she will most likely fail. This interest must also
translate into a vision for the company's growth. Even if the day-to-
day activities of a business are interesting to an entrepreneur, this is
not enough for success unless she can turn this interest into a vision of
growth and expansion. This vision must be strong enough that she can
communicate it to investors and employees.
Skill
All of the interest and vision cannot make up for a total lack of
applicable skill. As the head of a company, whether he has employees
or not, an entrepreneur must be able to wear many hats and do so
effectively. For instance, if he wants to start a business that creates
mobile games, he should have specialized knowledge in mobile
technology, the gaming industry, game design, mobile app marketing
or programming.
An entrepreneur must invest in her company. This investment may be
something less tangible, such as the time she spends or the skills or
reputation she brings with her, but it also tends to involve a significant
investment of assets with a clear value, whether they be cash, real
estate or intellectual property. An entrepreneur who will not or cannot
invest in her company cannot expect others to do so and cannot expect
it to succeed.
Organization and Delegation
While many new businesses start as a one-man show, successful
entrepreneurship is characterized by quick and stable growth. This
means hiring other people to do specialized jobs. For this reason,

entrepreneurship requires extensive organization and delegation of
tasks. It is important for entrepreneurs to pay close attention to
everything that goes on in their companies, but if they want their
companies to succeed, they must learn to hire the right people for the
right jobs and let them do their jobs with minimal interference from
management.
Risk and Rewards
Entrepreneurship requires risk. The measurement of this risk equates
to the amount of time and money you invest into your business.
However, this risk also tends to relate directly to the rewards
involved. An entrepreneur who invests in a franchise pays for
someone else's business plan and receives a respectable income, while
an entrepreneur who undertakes groundbreaking innovations risks
everything on an assumption that something revolutionary will work
in the market. If such a revolutionary is wrong, she can lose
everything. However, if she is right, she can suddenly become
extremely wealthy.
Entrepreneurship and Enterprise
ENTREPRENEUR ENTREPRENEURSHIP
Refers to a person Refers to a process
Creator of an enterprise Creation of an enterprise
Organizer Organization`
Planner Planning
Motivator Motivation
Decision Maker Decision
Leader Leadership
Innovator Innovation
Initiator Initiative
Technician/Administrator Technology/Administration
Importance and Relevance of the Entrepreneur

Benefits of Entrepreneurship to an Organization:
1. Development of managerial capabilities:
The biggest significance of entrepreneurship lies in the fact that it
helps in identifying and developing managerial capabilities of
entrepreneurs. An entrepreneur studies a problem, identifies its
alternatives, compares the alternatives in terms of cost and benefits
implications, and finally chooses the best alternative.
This exercise helps in sharpening the decision making skills of an
entrepreneur. Besides, these managerial capabilities are used by
entrepreneurs in creating new technologies and products in place of
older technologies and products resulting in higher performance.
2. Creation of organizations:
Entrepreneurship results into creation of organizations when
entrepreneurs assemble and coordinate physical, human and financial
resources and direct them towards achievement of objectives through
managerial skills.
3. Improving standards of living:
By creating productive organizations, entrepreneurship helps in
making a wide variety of goods and services available to the society
which results into higher standards of living for the people.
Possession of luxury cars, computers, mobile phones, rapid growth of
shopping malls, etc. are pointers to the rising living standards of
people, and all this is due to the efforts of entrepreneurs.
4. Means of economic development:
Entrepreneurship involves creation and use of innovative ideas,
maximization of output from given resources, development of
managerial skills, etc., and all these factors are so essential for the
economic development of a country.
Factors influencing entrepreneurship
Entrepreneurship is a complex phenomenon influenced by the
interplay of a wide variety of factors.
Some of the important factors are listed below:
1. Personality Factors:
Personal factors, becoming core competencies of entrepreneurs,
include:
(a) Initiative (does things before being asked for)

(b) Proactive (identification and utilisation of opportunities)
(c) Perseverance (working against all odds to overcome obstacles and
never complacent with success)
(d) Problem-solver (conceives new ideas and achieves innovative
solutions)
(e) Persuasion (to customers and financiers for patronisation of his
business and develops & maintains relationships)
(f) Self-confidence (takes and sticks to his decisions)
(g) Self-critical (learning from his mistakes and experiences of others)
(h) A Planner (collects information, prepares a plan, and monitors
performance)
(i) Risk-taker (the basic quality).
2. Environmental factors:
These factors relate to the conditions in which an entrepreneur has to
work. Environmental factors such as political climate, legal system,
economic and social conditions, market situations, etc. contribute
significantly towards the growth of entrepreneurship. For example,
political stability in a country is absolutely essential for smooth
economic activity.
Frequent political protests, bandhs, strikes, etc. hinder economic
activity and entrepreneurship. Unfair trade practices, irrational
monetary and fiscal policies, etc. are a roadblock to the growth of
entrepreneurship. Higher income levels of people, desire for new
products and sophisticated technology, need for faster means of
transport and communication, etc. are the factors that stimulate
entrepreneurship.
Thus, it is a combination of both personal and environmental factors
that influence entrepreneurship and brings in desired results for the
individual, the organization and the society.
Pros and Cons of being an entrepreneur
Entrepreneurship comes with its share of ups and downs.
The most obvious advantage is the opportunity to be your own boss.
Being in charge and making the important decisions regarding your
business can be fulfilling, but it can also be challenging.
Here are more thoughts on the pros and cons that come with being a
small business owner:

PROS
 CONTROL. You choose the work you like to do and that makes
the most of your strengths and skills. The result can be more job
satisfaction.
 EXCITEMENT. Entrepreneurship can be exciting and many
entrepreneurs consider their work highly enjoyable. Each day is filled
with new opportunities to challenge your abilities, skills, and
determination.
 FLEXIBILITY. Entrepreneurs can schedule their work hours
around other commitments, including spending quality time with their
families.
 FREEDOM. Freedom to work whenever they want, wherever
they want, and however they want draws many to entrepreneurship.
Most entrepreneurs don’t consider their work actual work because
they are doing something they love.
 RATIONAL SALARY. As an entrepreneur, your income is
directly related to your efforts and the success of your business.
CONS
 ADMINISTRATION. While making all the decisions can be a
benefit, it can also be a burden. Being an entrepreneur comes with a
lot of paperwork that can take up time and energy.
 COMPETITION. Staying competitive is critical as a small
business owner. You will need to differentiate your business from
others like yours in order to build a solid customer base and be
profitable.
 LONELINESS. It can be lonely and scary to be completely
responsible for the success or failure of your business.
 NO REGULAR SALARY. Being an entrepreneur often means
giving up the security of a regular paycheck. If business slows down,
your personal income can be at risk.
 WORK SCHEDULE. The work schedule of an entrepreneur can
be unpredictable. A major disadvantage to being an entrepreneur is
that it requires more work and longer hours than being an employee.
Types of Entrepreneurs
Depending upon the level of willingness to create innovative ideas,
there can be the following types of entrepreneurs:

1. Innovative entrepreneurs:
These entrepreneurs have the ability to think newer, better and more
economical ideas of business organization and management. They are
the business leaders and contributors to the economic development of
a country.
Inventions like the introduction of a small car ‘Nano’ by Ratan Tata,
organized retailing by Kishore Biyani, making mobile phones
available to the common may by Anil Ambani are the works of
innovative entrepreneurs.
2. Imitating entrepreneurs:
These entrepreneurs are people who follow the path shown by
innovative entrepreneurs. They imitate innovative entrepreneurs
because the environment in which they operate is such that it does not
permit them to have creative and innovative ideas on their own.
Such entrepreneurs are found in countries and situations marked with
weak industrial and institutional base which creates difficulties in
initiating innovative ideas.
In our country also, a large number of such entrepreneurs are found in
every field of business activity and they fulfill their need for
achievement by imitating the ideas introduced by innovative
entrepreneurs.
Development of small shopping complexes is the work of imitating
entrepreneurs. All the small car manufacturers now are the imitating
entrepreneurs.
3. Fabian entrepreneurs:
The dictionary meaning of the term ‘fabian’ is ‘a person seeking
victory by delay rather than by a decisive battle’. Fabian
entrepreneurs are those individuals who do not show initiative in
visualising and implementing new ideas and innovations wait for
some development which would motivate them to initiate unless there
is an imminent threat to their very existence.
4. Drone entrepreneurs:
The dictionary meaning of the term ‘drone’ is ‘a person who lives on
the labor of others’. Drone entrepreneurs are those individuals who
are satisfied with the existing mode and speed of business activity and
show no inclination in gaining market leadership. In other words,

drone entrepreneurs are die-hard conservatives and even ready to
suffer the loss of business.
5. Social Entrepreneur:
Social entrepreneurs drive social innovation and transformation in
various fields including education, health, human rights, workers’
rights, environment and enterprise development.
They undertake poverty alleviation objectives with the zeal of an
entrepreneur, business practices and dare to overcome traditional
practices and to innovate. Dr Mohammed Yunus of Bangladesh who
started Gramin Bank is a case of social entrepreneur.
Characteristics of a successful entrepreneur
Entrepreneurship is characterized by the following features:
1. Economic and dynamic activity:
Entrepreneurship is an economic activity because it involves the
creation and operation of an enterprise with a view to creating value
or wealth by ensuring optimum utilization of scarce resources. Since
this value creation activity is performed continuously in the midst of
uncertain business environment, therefore, entrepreneurship is
regarded as a dynamic force.
2. Related to innovation:
Entrepreneurship involves a continuous search for new ideas.
Entrepreneurship compels an individual to continuously evaluate the
existing modes of business operations so that more efficient and
effective systems can be evolved and adopted. In other words,
entrepreneurship is a continuous effort for synergy (optimization of
performance) in organizations.
3. Profit potential:
“Profit potential is the likely level of return or compensation to the
entrepreneur for taking on the risk of developing an idea into an actual
business venture.” Without profit potential, the efforts of
entrepreneurs would remain only an abstract and a theoretical leisure
activity.
4. Risk bearing:
The essence of entrepreneurship is the ‘willingness to assume risk’
arising out of the creation and implementation of new ideas. New

ideas are always tentative and their results may not be instantaneous
and positive.
An entrepreneur has to have patience to see his efforts bear fruit. In
the intervening period (time gap between the conception and
implementation of an idea and its results), an entrepreneur has to
assume risk. If an entrepreneur does not have the willingness to
assume risk, entrepreneurship would never succeed.
Entrepreneurial competencies
Entrepreneurial competencies are the skills necessary for an
entrepreneur to:
 venture into an enterprise
 organize and manage an enterprise ably and competently
 realize the goal for which the enterprise is established
These can be broadly classified under the following categories:
 Behavioral Competencies
 Enterprise Launching Competencies
 Enterprise Managing Competencies
Behavioral Competencies
 Initiative
 Systematic planning
 Creativity and innovation
 Risk taking and Risk Management
 Problem solving
 Persistence
 Quality performance
 Information management
 Persuasion and influencing abilities
Factors Affecting Entrepreneurial Growth
Entrepreneurship does not emerge and grow spontaneously. Rather it
is dependent upon some factors that affect entrepreneur growth. It
these factors are positive then the growth is more on the contrary less.
These factors are mainly environmental factors:
1. Economic Factor
2. Social Factor
3. Political Factor
4. Psychological Factor
5. Legal Factor
Role of entrepreneur in economic Development
 Promotes capital formation
 Promotes balanced regional development
 Reduces concentration of economic power
 Wealth creation & distribution
 Increasing GNP & per capita income
 Improvement in the standard of living
 Promotes country’s export trade
 Induces backward & forward linkages
 Facilitates overall development
 Creates large scale employment opportunities
 Challenges of women Entrepreneurs
 Women entrepreneurs face a series of problems right from the
beginning till the the enterprise functions. Being a woman itself poses
various problems to a woman entrepreneur, The problems of Indian
women pertains to her responsibility towards family, society and lion
work.
 The tradition, customs, socio cultural values, ethics, motherhood
subordinates to ling husband and men, physically weak, hard work
areas, feeling of insecurity, cannot be tough etc are some peculiar
problems that the Indian women are coming across while they jump
into entrepreneurship.
 Women in rural areas have to suffer still further. They face
tough resistance from men. They are considered as helpers. The
attitude of society towards her and constraints in which she has to live
and work are not very conducive.
 Besides the above basic problems the other problems faced by
women entrepreneurs are as follows:
 1. Family ties:
 Women in India are very emotionally attached to their families.
They are supposed to attend to all the domestic work, to look after the
children and other members of the family. They are over burden with
family responsibilities like extra attention to husband, children and in
laws which take away a lots of their time and energy. In such

situation, it will be very difficult to concentrate and run the enterprise
successfully.
 2. Male dominated society:
 Even though our constitution speaks of equality between sexes,
male chauvinism is still the order of the day. Women are not treated
equal to men. Their entry to business requires the approval of the head
of the family. Entrepreneurship has traditionally been seen as a male
preserve. All these puts a break in the growth of women
entrepreneurs.
 3. Lack of education:
 Women in India are lagging far behind in the field of education.
Most of the women (around sixty per cent of total women) are
illiterate. Those who are educated are provided either less or
inadequate education than their male counterpart partly due to early
marriage, partly due to son's higher education and partly due to
poverty. Due to lack of proper education, women entrepreneurs
remain in dark about the development of new technology, new
methods of production, marketing and other governmental support
which will encourage them to flourish.
 4. Social barriers:
 The traditions and customs prevailed in Indian societies towards
women sometimes stand as an obstacle before them to grow and
prosper. Castes and religions dominate with one another and hinders
women entrepreneurs too. In rural areas, they face more social
barriers. They are always seen with suspicious eyes.
 5. Shortage of raw materials:
 The scarcity of raw materials, sometimes nor, availability of
proper and adequate raw materials sounds the death-knell of the
enterprises run by women entrepreneurs. Women entrepreneurs really
face a tough task in getting the required raw material and other
necessary inputs for the enterprises when the prices are very high.
 6. Problem of finance:
 Women entrepreneurs stiffer a lot in raising and meeting the
financial needs of the business. Bankers, creditors and financial
institutes are not coming forward to provide financial assistance to
women borrowers on the ground of their less credit worthiness and
more chances of business failure. They also face financial problem
due to blockage of funds in raw materials, work-in-progress finished
goods and non-receipt of payment from customers in time.
7. Tough competition:
 Usually women entrepreneurs employ low technology in the
process of production. In a market where the competition is too high,
they have to fight hard to survive in the market against the organised
sector and their male counterpart who have vast experience and
capacity to adopt advanced technology in managing enterprises
 8. High cost of production:
 Several factors including inefficient management contribute to
the high cost of production which stands as a stumbling block before
women entrepreneurs. Women entrepreneurs face technology
obsolescence due to non-adoption or slow adoption to changing
technology which is a major factor of high cost of production.
 9.Low risk-bearing capacity:
 Women in India are by nature weak, shy and mild. They cannot
bear the amount risk which is essential for running an enterprise. Lack
of education, training and financial support from outsides also reduce
their ability to bear the risk involved in an enterprises.
 10 Limited mobility:
 Women mobility in India is highly limited and has become a
problem due to traditional values and inability to drive vehicles.
Moving alone and asking for a room to stay out in the night for
business purposes are still looked upon with suspicious eyes.
Sometimes, younger women feel uncomfortable in dealing with men
who show extra interest in them than work related aspects.
 11. Lack of entrepreneurial aptitude:
 Lack of entrepreneurial aptitude is a matter of concern for
women entrepreneurs. They have no entrepreneurial bent of mind.
Even after attending various training programmes on entrepreneur
ship women entrepreneurs fail to tide over the risks and troubles that
may come up in an organizational working.
 12. Limited managerial ability:

 Management has become a specialised job which only efficient
managers perform. Women entrepreneurs are not efficient in
managerial functions like planning, organising, controlling,
coordinating, staffing, directing, motivating etc. of an enterprise.
Therefore, less and limited managerial ability of women has become a
problem for them to run the enterprise successfully.
 13. Legal formalities:
 Fulfilling the legal formalities required for running an enterprise
becomes an upheaval task on the part of an women entrepreneur
because of the prevalence of corrupt practices in government offices
and procedural delays for various licenses, electricity, water and shed
allotments. In such situations women entrepreneurs find it hard to
concentrate on the smooth working of the enterprise.
 14. Exploitation by middle men:
 Since women cannot run around for marketing, distribution and
money collection, they have to depend on middle men for the above
activities. Middle men tend to exploit them in the guise of helping.
They add their own profit margin which result in less sales and lesser
profit.
 15. Lack of self confidence:
 Women entrepreneurs because of their inherent nature, lack of
self-confidence which is essentially a motivating factor in running an
enterprise successfully. They have to strive hard to strike a balance
between managing a family and managing an enterprise. Sometimes
she has to sacrifice her entrepreneurial urge in order to strike a
balance between the two.
 Types of Entrepreneurs
 Depending upon the level of willingness to create innovative
ideas, there can be the following types of entrepreneurs:
 1. Innovative entrepreneurs:
 These entrepreneurs have the ability to think newer, better and
more economical ideas of business organization and management.
They are the business leaders and contributors to the economic
development of a country.

 Inventions like the introduction of a small car ‘Nano’ by Ratan
Tata, organised retailing by Kishore Biyani, making mobile phones
available to the common may by Anil Ambani are the works of
innovative entrepreneurs.
 2. Imitating entrepreneurs:
 These entrepreneurs are people who follow the path shown by
innovative entrepreneurs. They imitate innovative entrepreneurs
because the environment in which they operate is such that it does not
permit them to have creative and innovative ideas on their own.
 Such entrepreneurs are found in countries and situations marked
with weak industrial and institutional base which creates difficulties
in initiating innovative ideas.
 In our country also, a large number of such entrepreneurs are
found in every field of business activity and they fulfill their need for
achievement by imitating the ideas introduced by innovative
entrepreneurs.
 Development of small shopping complexes is the work of
imitating entrepreneurs. All the small car manufacturers now are the
imitating entrepreneurs.
 3. Fabian entrepreneurs:
 The dictionary meaning of the term ‘fabian’ is ‘a person seeking
victory by delay rather than by a decisive battle’. Fabian
entrepreneurs are those individuals who do not show initiative in
visualising and implementing new ideas and innovations wait for
some development which would motivate them to initiate unless there
is an imminent threat to their very existence.
 4. Drone entrepreneurs:
 The dictionary meaning of the term ‘drone’ is ‘a person who
lives on the labor of others’. Drone entrepreneurs are those
individuals who are satisfied with the existing mode and speed of
business activity and show no inclination in gaining market
leadership. In other words, drone entrepreneurs are die-hard
conservatives and even ready to suffer the loss of business.
 5. Social Entrepreneur:

 Social entrepreneurs drive social innovation and transformation
in various fields including education, health, human rights, workers’
rights, environment and enterprise development.
 They undertake poverty alleviation objectives with the zeal of an
entrepreneur, business practices and dare to overcome traditional
practices and to innovate. Dr Mohammed Yunus of Bangladesh who
started Gramin Bank is a case of social entrepreneur.
Social Entrepreneurship
Definition, Importance and Social Responsibilities-NGOs
Social entrepreneurship is the attempt to draw upon business
techniques to find solutions to social problems
Social entrepreneurs drive social innovation and transformation in
various fields including education, health, environment and enterprise
development. They pursue poverty alleviation goals with
entrepreneurial zeal, business methods and the courage to innovate
and overcome traditional practices. A social entrepreneur, similar to a
business entrepreneur, builds strong and sustainable organizations,
which are either set up as not-for-profits or companies.
A social entrepreneur is a leader or pragmatic visionary who:
 Achieves large scale, systemic and sustainable social change
through a new invention, a different approach, a more rigorous
application of known technologies or strategies, or a combination of
these.
 Focuses first and foremost on the social and/or ecological value
creation and tries to optimize the financial value creation.
 Innovates by finding a new product, a new service, or a new
approach to a social problem.
 Continuously refines and adapts approach in response to
feedback.
 Combines the characteristics represented by Richard Branson
and Mother Teresa.
The Schwab Foundation employs the following criteria when looking
for leading social entrepreneurs: Innovation, Sustainability, Reach and
social impact.
Social entrepreneurs share some come common traits including:

 An unwavering belief in the innate capacity of all people to
contribute meaningfully to economic and social development
 A driving passion to make that happen.
 A practical but innovative stance to a social problem, often
using market principles and forces, coupled with dogged
determination that allows them to break away from constraints
imposed by ideology or field of discipline, and pushes them to take
risks that others wouldn't dare.
 A zeal to measure and monitor their impact. Entrepreneurs have
high standards, particularly in relation to their own organization’s
efforts and in response to the communities with which they engage.
Data, both quantitative and qualitative, are their key tools, guiding
continuous feedback and improvement.
 A healthy impatience. Social Entrepreneurs cannot sit back and
wait for change to happen – they are the change drivers.
Social entrepreneurship is
 About applying practical, innovative and sustainable approaches
to benefit society in general, with an emphasis on those who are
marginalized and poor.
 A term that captures a unique approach to economic and social
problems, an approach that cuts across sectors and disciplines
grounded in certain values and processes that are common to each
social entrepreneur, independent of whether his/ her area of focus has
been education, health, welfare reform, human rights, workers' rights,
environment, economic development, agriculture, etc., or whether the
organizations they set up are non-profit or for-profit entities.
 It is this approach that sets the social entrepreneur apart from the
rest of the crowd of well-meaning people and organizations who
dedicate their lives to social improvement.
The social responsibility of NGO Non-profit organizations have
considerably changed in recent years. For example, they are now
recognized as one of the most prominent social actors able to carry
out political incidence and to provoke social changes. This new role
has motivated several debates such as what is NGO pursuing and their
legitimacy to participate in political debates, while its recognition like
a necessary and important social actor is maintained. At the same
time, NGO undergo a construction process, with an important
increase of their activities and a growing organizing complexity.
As organizations, they have continuous interactions with the
environment. This fact provokes that the own organizations think
about the basic ambits of social responsibility they should take into
account: which responsibilities they should share with other sectors
and which ones are exclusive for NGO?
The fact that a company evolves towards a responsible organization,
may occur due to several reasons. In some cases, responsibilities are
accepted because of some internal values, but some other times are
not necessarily like that. Other reasons to develop social responsibility
politics could be assigning some values to their trademark, motivating
the employees so that they identify themselves with the company,
generating bigger benefits or minimizing risks.
The Social Responsibility of Non-Profit Organizations 11 “If we are
not responsible, we will have no projects with enterprises and the
public administration. If we plan social responsibility together, we
would have a wider social project”. Extract from an interview with an
organization However, when analyzing the motivations that may
promote social responsibility in the third sector, it is appreciated the
shallowness of company’s motivations, except for those ones related
to internal values. Basically, the values are present in non-profit
organizations from its origin and in many cases; they are the very
reason of its foundation, since these organizations are created to
promote these values. Thus, it may seem that the third sector
organizations are responsible 'per se' and therefore, to implement
social responsibility politics does not apply to them. However, to
achieve the social change pursued by their mission, organizations
participate in the society carrying out everyday activities in several
environments. They usually face decisions-making processes that may
help to improve their impact. But what would be the value of the
social changes if while trying to achieve them, the organization leave
aside the values promoted by the mission?. The social responsibility
of nonprofit organizations focus on the way these organizations act
according to the values they promote. Basically, it is a matter of

coherence between the ‘way of doing’ and the ‘reason of being’ of the
organization.
Problems of SMEs and Prospects
Any government can take advantages by their cottage and small scale
industries if they take some important steps for this industry. We
discuss the important measures to solve the problems of cottage and
small scale industries under these headings :
1. Credit Facilities :-
The government should provide the credit to small and cottage
industries at lower rate of interest. Further commercial banks are also
providing loan to develops the industries.
2. Industrial Estates :-
The government has set up the number of industrial estates in the
different cities. These areas have been provided various facilities like,
roads, banking, and transport facilities to encourage the small scale
industries.
3. Testing Laboratories :-
The government has established the testing laboratories to maintain
the prescribed standard of cottage industries product.
4. Supply of Designs :-
The government also provides the new models and designed to
producers to improve the qualify of cottage industry.
5. Publicity :-
The government has set up the display centers and show room,s inside
and outside the country to increase the sale of cottage industry
product.
6. Facility of Raw Material :-
The government imports the raw material for the cottage industries
from abroad and provides them at lower price to encourage them.
7. Purchase of Cottage Industry Product :-
The government also purchases finished products from them and sells
it at show room. Govt display centers in side and out side the country
are creating the demand.
8. Protection Against Foreign Competitions :-
The government has also provided protection to home industry by
imposing heavy duties on the imports. Still there is a need of further

protection. Smuggling should be also controlled.
9. Establishment of Training Institutions :-
The government has set up various institutions like industrial,
vocational, commercial and polytechnic institutions to provide the
qualified workers to the cottage and small scale industries.
10. Carpet Centers :-
For the training of weavers the small corporation have set up carpet
training development centers. These are working very usefully.
11. Handicraft Centers :-
Handicrafts development centers have been set up to promote the
handicrafts.
12. Advisory Services :-
The small scale industries advisory services has been set up in each
province to provide guidance to the new comers in small scale
industry.
Causes and Symptoms of sickness – cures of sickness
Definition According to companies (2nd Amendment) Act, 2002
“Sick Industrial Company” means an unit which has accumulated
losses in any financial year which are equal to 50% or more of its
average net worth during 4 years immediately preceding such
financial years.
Causes of industrial sickness
We can say pertaining to the factors which are within the control
of management. This sickness arises due to internal disorder in the
areas justified as following:
a) Lack of Finance: This including weak equity base, poor utilization
of assets, inefficient working capital management, absence of costing
& pricing, absence of planning and budgeting and inappropriate
utilization or diversion of funds.
b) Bad Production Policies : The another very important reason for
sickness is wrong selection of site which is related to production,
inappropriate plant & machinery, bad maintenance of Plant &
Machinery, lack of quality control, lack of standard research &
development and so on.
c) Marketing and Sickness: This is another part which always affects
the health of any sector as well as SSI. This including wrong demand

forecasting, selection of inappropriate product mix, absence of
product planning, wrong market research methods, and bad sales
promotions.
d) Inappropriate Personnel Management: The another internal reason
for the sickness of SSIs is inappropriate personnel
management policies which includes bad wages and salary
administration, bad labor relations, lack of behavioral approach causes
dissatisfaction among the employees and workers.
e) Ineffective Corporate Management: Another reason for the sickness
of SSIs is ineffective or bad corporate management which includes
improper corporate planning, lack of integrity in top management,
lack of coordination and control etc.
External causes for sickness
a) Personnel Constraint: The first for most important reason for the
sickness of small scale industries are non availability of skilled labor
or manpower wages disparity in similar industry and general labor
invested in the area.
b) Marketing Constraints: The second cause for the sickness is related
to marketing. The sickness arrives due to liberal licensing policies,
restrain of purchase by bulk purchasers, changes in global marketing
scenario, excessive tax policies by govt. and market recession.
c) Production Constraints: This is another reason for the sickness
which comes under external cause of sickness. This arises due to
shortage of raw material, shortage of power, fuel and high prices,
import-export restrictions.
d) Finance Constraints: The external cause for the sickness of SSIs is
lack of finance. This arises due to credit restrains policy, delay in
disbursement of loan by govt., unfavorable investments, fear
of nationalization.
e) Credit squeeze initiated by the government policies.
Govt. policies on revival of sickness and remedial measures
Industrial sickness (industry not in operation) in our country is a
general phenomenon, which has existed along with healthy industrial
enterprises. Sickness has registered a quantum jump with the arrival
of the new economic order, ushered in by liberalization and
globalization. Industrial sickness can be found in any state of India as

well as in some other countries. Industrial sick units caused
unemployment and social unrest in an economy. Hence, suitable and
phase wise remedial measures required through Government as well
as by private sector participation. These sick unit revivals could be
done through following measures:
 Adoption of latest technology & modern production process &
equipment, proper infrastructure development around existing unit.
 Minimizing input costs and adopting economy of scale,
adequate provision for financial requirements, exploring new market
for its product.
 On time delivery & strict quality control measures should be
adopted for its product, cost minimization, modernization of existing
infrastructure with time, proper management should be in place to
stop/reduce wastage, potential capacity utilization.
 Adopting true professionalism and developing proper work
culture & ethics, fixing responsibility and making accountable to
concern authority, promotion as per work efficiency not as per
number of years in office.
 To drive knowledge transfer and exchange of ideas between the
supply and demand sides of technology-enabled markets through a
high quality, easy to use service.
 To provide a forum for a sound business voice to inform
government of its technology needs and about issues, such as
regulation. This could ultimately enhance or inhibit innovation in
industry.
 Maximum exploitation of new technologies to gain competitive
advantage.
 For funding of sick unit various model could be consider like
public funding, public-private funding and competitive private
funding.
 For country like India, technology should be cost effective and
combination of labour-capital intensive instead of only capital
intensive.
 To deliver improved industrial performance through innovation
and new collaborations by driving the flow of people, knowledge and

experience between business and the science-base, between
businesses and across sectors.
 Incorporating innovative ideas to expand business rather than
only focusing on bringing new technology into business.
 By bringing own distribution center, delivery time and price
competitiveness can be brought in.
 Recognize and apply changing patterns of innovation before
others do;
 Be more practical about market demand of your product rather
than wholly depending upon research;
 Quality of product of global level/standard instead of focusing
only on Indian market.
 Think beyond using latest technology – skill needed to merger
& acquisition of new business, design skills to develop new products
and marketing skills to connect with new consumers and markets;
 Be medium for the spread of global best practice and new
opportunities for domestic firms through linkages with global market
and firms;
 Be master in using/applying new ideas (innovators) rather than
merely generating new ideas (inventors) – demanding higher
standards and focusing managers on adopting and adapting external
knowledge;
Two types of innovation could be adopted,
1. Product or services innovation;
2. Process innovation,
1. Product or services innovation; this is all about launching new
or improved products (or services) on to the market.
Its advantages include (note links to marketing):
a. "First mover advantage’ – which can include some of the
following
b. Higher prices and profitability
c. Added value
d. Opportunity to build early customer loyalty
e. Enhanced reputation as an innovative company
f. Public Relations – e.g. news coverage
g. Increased market share
2. Process innovation, this is about finding better or more efficient
ways of producing existing products, or delivering existing services
Its advantages include:
a. Reduced costs
b. Improved quality
c. responsive customer service
d. Greater flexibility
Recognizing and acting upon new emerging opportunities within their
industries before other firms do; Be focused on solutions rather than
products or services.
Some other more general remedial measures for Industrial Sickness
mentioned below:
 Procedural delay in getting licenses/sanctions etc should be
minimized, so that Cost over-runs should not happen.
 Rationalization of wage structure, apt handling of labor
problems, gradual reduction of excessive manpower, recruitment of
highly trained/skilled personnel.
 Latest marketing techniques & marketing strategy with the help
of audio, video & print media etc. for its product so that better
revenue realization occurred, competitive pricing policy, proper
feedback system should be in place for it product with best marketing
research tool.
 Optimum utilization and mobilization of its resources with
proper financial planning & dividend distribution policy.
 Proper financial management system to fill the gap of working
capital and prohibit its unauthorized application.
 Minimizing undue interference of labor/trade union particularly
West Bengal, Haryana, Orissa, etc.
 De-centralization of power, proper setup for labor management
information system.
 Adequate system for proper check and balance, timely
diversification.
 Research & Development is essential part of any organization
but it should not involved undue expenditure.
Rural Entrepreneurship

Rural entrepreneurs are those who carry out entrepreneurial
activities by establishing industrial and business units in the
rural sector of the economy. In other words, establishing
industrial and business units in the rural areas refers to rural
entrepreneurship. In simple words, rural entrepreneurship
implies entrepreneurship emerging in rural areas. Or, say, rural
entrepreneurship implies rural industrialisation. Thus, we can
say, entrepreneurship precedes industrialization.
Definition:
Rural industries and business organisations in rural areas generally
associated with agriculture and allied activities to agriculture.
According to KVIC (Khadi and Village Industry Commission),
"village industries or Rural industry means any industry located in
rural areas, population of which does not exceed 10,000 or such other
figure which produces any goods or renders any services with or
without use of power and in which the fixed capital investment per
head of an artisan or a worker does not exceed a thousand rupees".
The modified definition of rural industries has been given by
Government of India in order to enlarge its scope. According to
Government of India, "Any industry located in rural area, village or
town with a population of 20,000 and below and an investment of Rs.
3 crores in plant and machinery is classified as a village industry."
Types of Rural Industries:
All the village industries come under the following broad categories :
Agro Based Industries: like sugar industries, jaggery, oil processing
from oil seeds, pickles, fruit juice, spices, diary products etc.
Forest Based Industries: like wood products, bamboo products,
honey, coir industry, making eating plates from leaves.
Mineral based industry: like stone crushing, cement industries, red
oxide making, wall coating powders etc.
Textile Industry: like spinning, weaving, colouring, bleaching.
Engineering and Services: like agriculture equipments, tractors and
pumpsets repairs etc.
Entrepreneurial support systems and role of government in
Entrepreneurship Development

The Government of India has undertaken several initiatives and
instituted policy measures to foster a culture of innovation and
entrepreneurship in the country. Job creation is a foremost
challenge facing India. With a significant and unique
demographic advantage, India, however, has immense potential to
innovate, raise entrepreneurs and create jobs for the benefit of the
nation and the world.
In the recent years, a wide spectrum of new programmes and
opportunities to nurture innovation have been created by the
Government of India across a number of sectors. From engaging
with academia, industry, investors, small and big entrepreneurs,
non-governmental organizations to the most underserved sections
of society.
Recognising the importance of women entrepreneurship and
economic participation in enabling the country’s growth and
prosperity, Government of India has ensured that all policy
initiatives are geared towards enabling equal opportunity for
women. The government seeks to bring women to the forefront of
India’s entrepreneurial ecosystem by providing access to loans,
networks, markets and trainings.
A few of India’s efforts at promoting entrepreneurship and
innovation are:
Startup India: Through the Startup India initiative, Government
of India promotes entrepreneurship by mentoring, nurturing and
facilitating startups throughout their life cycle. Since its launch in
January 2016, the initiative has successfully given a head start to
numerous aspiring entrepreneurs. With a 360 degree approach to
enable startups, the initiative provides a comprehensive four-week
free online learning program, has set up research parks,
incubators and startup centres across the country by creating a
strong network of academia and industry bodies. More
importantly, a ‘Fund of Funds’ has been created to help startups
gain access to funding. At the core of the initiative is the effort to
build an ecosystem in which startups can innovate and excel
without any barriers, through such mechanisms as online
recognition of startups, Startup India Learning Programme,

Facilitated Patent filing, Easy Compliance Norms, Relaxed
Procurement Norms, incubator support, innovation focused
programmes for students, funding support, tax benefits and
addressing of regulatory issues.
Make in India: Designed to transform India into a global design
and manufacturing hub, the Make in India initiative was launched
in September 2014. It came as a powerful call to India’s citizens
and business leaders, and an invitation to potential partners and
investors around the world to overhaul out-dated processes and
policies, and centralize information about opportunities in India’s
manufacturing sector. This has led to renewed confidence in
India’s capabilities among potential partners abroad, business
community within the country and citizens at large. The plan
behind Make in India was one of the largest undertaken in recent
history. Among several other measures, the initiative has ensured
the replacement of obsolete and obstructive frameworks with
transparent and user-friendly systems. This has in turn helped
procure investments, foster innovation, develop skills, protect
intellectual property and build best-in-class manufacturing
infrastructure.
Atal Innovation Mission (AIM): AIM is the Government of
India’s endeavour to promote a culture of innovation and
entrepreneurship, and it serves as a platform for promotion of
world-class Innovation Hubs, Grand Challenges, start-up
businesses and other self-employment activities, particularly in
technology driven areas. In order to foster curiosity, creativity
and imagination right at the school, AIM recently launched Atal
Tinkering Labs (ATL) across India. ATLs are workspaces where
students can work with tools and equipment to gain hands -on
training in the concepts of STEM (Science, Technology,
Engineering and Math). Atal Incubation Centres (AICs) are
another programme of AIM created to build innovative start-up
businesses as scalable and sustainable enterprises. AICs provide
world class incubation facilities with appropriate physical
infrastructure in terms of capital equipment and operating
facilities. These incubation centres, with a presence across India,

provide access to sectoral experts, business planning support,
seed capital, industry partners and trainings to encourage
innovative start-ups.
Support to Training and Employment Programme for Women
(STEP): STEP was launched by the Government of India’s
Ministry of Women and Child Development to train women with
no access to formal skill training facilities, especially in rural
India. The Ministry of Skill Development & Entrepreneurship and
NITI Aayog recently redrafted the Guidelines of the 30 -year-old
initiative to adapt to present-day needs. The initiative reaches out
to all Indian women above 16 years of age. The progra mme
imparts skills in several sectors such as agriculture, horticulture,
food processing, handlooms, traditional crafts like embroidery,
travel and tourism, hospitality, computer and IT services.
Jan Dhan- Aadhaar- Mobile (JAM): JAM, for the first time, is a
technological intervention that enables direct transfer of subsidies
to intended beneficiaries and, therefore, eliminates all
intermediaries and leakages in the system, which has a protential
impact on the lives of millions of Indian citizens. Besides serving
as a vital check on corruption, JAM provides for accounts to all
underserved regions, in order to make banking services accessible
down to the last mile.
Digital India: The Digital India initiative was launched to
modernize the Indian economy to makes all government services
available electronically. The initiative aims to transform India
into a digitally-empowered society and knowledge economy with
universal access to goods and services. Given historically poor
internet penetration, this initiative aims to make available high-
speed internet down to the grassroots. This program aims to
improve citizen participation in the digital and financial space,
make India’s cyberspace safer and more secure,abd improve ease
of doing business. Digital India hopes to achieve equity and
efficiency in a country with immense diversity by making digital
resources and services available in all Indian languages.
Biotechnology Industry Research Assistance
Council (BIRAC): BIRAC is a not-for-profit Public-Sector

Enterprise, set up by Department of Biotechnology to strengthen
and empower emerging biotechnology enterprises. It aims to
embed strategic research and innovation in all biotech enterprises,
and bridge the existing gaps between industry and academia. The
ultimate goal is to develop high-quality, yet affordable, products
with the use of cutting edge technologies. BIRAC has initiated
partnerships with several national and global partners for building
capacities of the Indian biotech industry, particularly start-ups
and SME’s, and has facilitated several rapid developments in
medical technology.
Department of Science and Technology (DST): The DST
comprises several arms that work across the spectrum on all
major projects that require scientific and technological
intervention. The Technology Interventions for Disabled and
Elderly, for instance, provides technological solutions to address
challenges and improve quality of life of the elderly in India
through the application of science and technology. On the other
hand, the ASEAN-India Science, Technology and
Innovation Cooperation works to narrow the development gap and
enhance connectivity between the ASEAN countries. It
encourages cooperation in science, technology and innovation
through joint research across sectors and provides fellowships to
scientists and researchers from ASEAN member states with
Indian R&D/ academic institutions to upgrade their research skills
and expertise.
Stand-Up India: Launched in 2015, Stand-Up India seeks to
leverage institutional credit for the benefit of India’s
underprivileged. It aims to enable economic participation of, and
share the benefits of India’s growth, among women entrepreneurs,
Scheduled Castes and Scheduled Tribes. Towards this end, at
least one women and one individual from the SC or ST
communities are granted loans between Rs.1 million to Rs.10
million to set up greenfield enterprises in manufacturing, services
or the trading sector. The Stand-Up India portal also acts as a
digital platform for small entrepreneurs and provides information
on financing and credit guarantee.

Trade related Entrepreneurship Assistance and Development
(TREAD): To address the critical issues of access to credit among
India’s underprivileged women, the TREAD programme enables
credit availability to interested women through non-governmental
organizations (NGOs). As such, women can receive support of
registered NGOs in both accessing loan facilities, and receiving
counselling and training opportunities to kick-start proposed
enterprises, in order to provide pathways for women to take up non -
farm activities.
Pradhan Mantri Kaushal VikasYojana (PMKVY): A flagship
initiative of the Ministry of Skill Development & Entrepreneurship
(MSDE), this is a Skill Certification initiative that aims to train youth
in industry-relevant skills to enhance opportunities for livelihood
creation and employability. Individuals with prior learning experience
or skills are also assessed and certified as a Recognition of Prior
Learning. Training and Assessment fees are entirely borne by the
Government under this program.
National Skill Development Mission: Launched in July 2015, the
mission aims to build synergies across sectors and States in skilled
industries and initiatives. With a vision to build a ‘Skilled India’ it is
designed to expedite decision-making across sectors to provide skills
at scale, without compromising on quality or speed. The seven sub -
missions proposed in the initial phase to guide the mission’s skilling
efforts across India are: (i) Institutional Training (ii) Infrastructure
(iii) Convergence (iv) Trainers (v) Overseas Employment (vi)
Sustainable Livelihoods (vii) Leveraging Public Infrastructure.
Science for Equity Empowerment and Development
(SEED): SEED aims to provide opportunities to motivated scientists
and field level workers to undertake action-oriented, location specific
projects for socio-economic gain, particularly in rural areas. Efforts
have been made to associate national labs and other specialist S&T
institutions with innovations at the grassroots to enable access to
inputs from experts, quality infrastructure. SEED emphasizes equity
in development, so that the benefits of technological accrue to a vast
section of the population, particularly the disadvantaged.

UNIT 2
Entrepreneurial Motivation: Concept and Theories
Entrepreneurial motivation is the process of transforming an ordinary
individual to a powerful businessman, who can create opportunities
and helps in maximizing wealth and economic development. It is
defined as various factors stimulate desires and activates enthusiasm
in entrepreneurs which make them attain a particular goal.
Entrepreneurship is the process of identifying strengths and
opportunities which help in the realization of one’s dreams for
designing, developing and running a new business by facing threats
and risks effectively.
Motivation makes entrepreneur by fulfilling higher level needs such
as recognition, esteem, and self-actualization. Various theories
explained motivation as an influencing concept, it can bring out
hidden talents and creativity, and it contributes to the individual goals
and society development. Maslow’s need hierarchy theory,
Hertzberg’s two-factor theory, and David MC Clelland’s acquired
needs theory proved that motivation can bring energy, enthusiasm,
creativity and efficiencies in fulfilling the desired objectives.
Motivation activates innate strengths to achieve a particular goal,
many questions arise during knowing this concept such as why can’t
all the human beings become leader or entrepreneurs even though
they face same motivation during his/her lifetime? Who can become
effective motivators? What type of motivation can influence one’s
behavior? Is the extent of motivation decides the power of
externalized behavior? Etc, entrepreneurial motivation is a
psychological process in which all the motives may not influence with
the same intensity, it varies with the perception levels of the
individuals and factors responsible for the motivation.
Nature of Motivation
The nature of motivation emerging out of above definitions can be
expressed as follows:
1. Motivation is internal to man
Motivation cannot be seen because it is internal to man. It is
externalized via behaviour. It activates the man to move toward his /
her goal.

2. A Single motive can cause different behaviours
A person with a single desire or motive to earn prestige in the society
may move towards to join politics, attain additional education and
training, join identical groups, and change his outward appearance.
3.Different motives may result in single behaviour
It is also possible that the same or single behaviour may be caused by
many motives. For example, if a person buys a car, his such behaviour
may be caused by different motives such as to look attractive, be
respectable, gain acceptance from similar group of persons,
differentiate the status, and so on.
4.Motives come and go
Like tides, motives can emerge and then disappear. Motives emerged
at a point of time may not remain with the same intensity at other
point of time. For instance, an entrepreneur overly concerned about
maximization of profit earning during his initial age as entrepreneur
may turn his concern towards other higher things like contributing
towards philanthropic activities in social health and education once he
starts earning sufficient profits.
5.Motives interact with the environment
The environment in which we live at a point of time may either
trigger or suppress our motives. You probably have experienced
environment or situation when the intensity of your hunger picked up
just you smelled the odour of palatable food.
You may desire an excellent performance bagging the first position in
your examination but at the same time may also be quite sensitive to
being shunned and disliked by your class mates if you really perform
too well and get too much of praise and appreciation from your
teachers. Thus, what all this indicates is that human behaviour is the
result of several forces differing in both direction and intent.
Entrepreneurial Motivating Factors
Most of the researchers have classified all the factors motivating
entrepreneurs into internal and external factors as follows:
Internal Factors
These include the following factors:
1. Desire to do something new.
2. Become independent.

3. Achieve what one wants to have in life.
4. Be recognized for one’s contribution.
5. One’s educational background.
6. One’s occupational background and experience in the relevant
field.
External Factors
These include:
1. Government assistance and support.
2. Availability of labour and raw material.
3. Encouragement from big business houses.
4. Promising demand for the product.
Theories of Entrepreneurship: An entrepreneur, as described by the

Small Business Association, puts together a business and accepts the
associated risk to make a profit. While this definition serves as a
simple but accurate description of entrepreneurs, it fails to explain the
phenomena of entrepreneurship itself. A number of theories exist, but
all of them fall into one of five main categories
Economic Theories
Economic entrepreneurship theories date back to the first half of the
1700s with the work of Richard Cantillon, who introduced the idea of
entrepreneurs as risk takers. The classic, neoclassical and Austrian
Market process schools of thought all pose explanations for
entrepreneurship that focus, for the most part, on economic conditions
and the opportunities they create. Economic theories of
entrepreneurship tend to receive significant criticism for failing to
recognize the dynamic, open nature of market systems, ignoring the
unique nature of entrepreneurial activity and downplaying the diverse
contexts in which entrepreneurship occurs.
Resource-Based Theories
Resource-based theories focus on the way individuals leverage
different types of resources to get entrepreneurial efforts off the
ground. Access to capital improves the chances of getting a new
venture off the ground, but entrepreneurs often start ventures with
little ready capital. Other types of resources entrepreneurs might
leverage include social networks and the information they provide, as

well as human resources, such as education. In some cases, the
intangible elements of leadership the entrepreneur adds to the mix
operate as resource that a business cannot replace.
Psychological Theories
Psychological theories of entrepreneurship focus on the individual and
the mental or emotional elements that drive entrepreneurial
individuals. A theory put forward by psychologist David
McCLelland, a Harvard emeritus professor, offers that entrepreneurs
possess a need for achievement that drives their activity. Julian Rotter,
professor emeritus at the University of Connecticut, put forward a
locus of control theory. Rotter’s theory holds that people with a strong
internal locus of control believe their actions can influence the
external world and research suggests most entrepreneurs possess trait.
A final approach, though unsupported by research, suggests
personality traits ranging from creativity and resilience to optimism
drive entrepreneurial behavior.
Sociological/Anthropological Theories
The sociological theory centers its explanation for entrepreneurship
on the various social contexts that enable the opportunities
entrepreneurs leverage. Paul D. Reynolds, a George Washington
University research professor, singles out four such contexts: social
networks, a desire for a meaningful life, ethnic identification and
social-political environment factors. The anthropological model
approaches the question of entrepreneurship by placing it within the
context of culture and examining how cultural forces, such as social
attitudes, shape both the perception of entrepreneurship and the
behaviors of entrepreneurs.
Opportunity-Based Theory
Prolific business management author, professor and corporate
consultant, Peter Drucker put forward an opportunity-based theory.
Drucker contends that entrepreneurs excel at seeing and taking
advantage of possibilities created by social, technological and cultural
changes. For example, where a business that caters to senior citizens
might view a sudden influx of younger residents to a neighborhood as
a potential death stroke, an entrepreneur might see it as a chance to
open a new club.

A prospective entrepreneur is interested to engross himself in merely
those businessprocesses, which are practicable and have a demand in
the market. At the same time heis required to decide on a particular
alternative out of unlike options obtainable to him.For instance, he
has to decide on a meticulous business or industry then he is required
toappraise what will be the form of that particular product or service
and possibilities. Inreality, an entrepreneur is termed as an
opportunities hunter. He is supposed torecognize, investigate and then
decide on a feasible business opportunity. Businessopportunity is an
eye-catching project in terms of sufficient rate of return,
whichmotivates the entrepreneur to acknowledge that particular
project for making investmentdecision. Entrepreneurs in general
evaluate diverse possibilities and decide on just
highest reward paying opportunity for implementation. Thus a
business prospect is beingcompetent of as commercially feasible. In
this background, two major criterion are vitalfor making an option is a
business opportunity.
Favourable market demand or surplus of demand over obtainable
supply on handin the market andAmple rate of return on investment
that is usually equal to normal rate of returnand risk premium attached
to that particular business prospect.
Entrepreneurial Strategy:
New entry refers to: Offering a new product to an established or new
market.
Offering an established product to a new market.
Creating a new organization.
Entrepreneurial strategy – The set of decisions, actions, and reactions
that first generate, and then exploit over time, a new entry.
Generation of new Entry Opportunity
One important effort in entrepreneurship are new ventures, new
businesses include: 1. offers all new products to market; 2. offer an
existing product; 3.menciptakan a new organisasai regardless of
whether the product is new to competition or consumers.
Creation of a New Business Opportunities
Resources as a source of competitive advantage, when a company
starting a new business, these resources can be combined to provide

the capacity for firms to achieve superior performance yng, that
resource becomes the basis of superior performance over its
competitors, resources must be valuable, rare and can not be imitated.
To make a note of the growing business market and technological
knowledge, and assess the benefits from new business opportunities.
Strategy for the Exploitation of Business New Business
Source of competitive advantage is to be the first in introducing new
products or creating new business for the new venture could allow a
profit that could improve performance. Hi this include:
1. Develop an early mover advantage means the cost to be the first
to sell a product on the market
2. Early mover competitive competition, the first few customers
continues to grow and will eventually disappear
3. Early mover in the use of distribution channels, since the
beginning have the opportunity to choose and develop strong
relationships with suppliers and distribution channels of the most
important.
4. Early mover in consumer satisfaction with goods dihasillkan
taste, according to market share target
5. Early movers gain the skills learned through participation in
existing products, to monitor changes in the market that it becomes
difficult, building a network.
Consumer uncertainty and disadvantage First Mover
Introducing new products to the market that involves all the elements
and there is no uncertainty for consumers about new products that are
not convinced that the new product has the advantage of old products,
and consumers are reluctant to move new keproduk, the proper way to
introduce new products with advertising that is often through the
media print and electronic, and with the direction or demonstrating
new products at the show or efen-specific efen so that consumers
could be interested and willing to become repeat customers.
A Objective of recognition of Business Opportunities
Appraise the likelihood of developing and utilizing physical
resources.Assess and guesstimate the capital, labour transport, power
fuel, raw material forfeasible industries.Categorize those industries,
which are not based on local resourcesLearn the short and long run

development possibilities of the province withrespect to
agriculture.Review the collision of achievement in financial
resources.Study and scrutinize the SMEs potential.
B Factors that influence the Business Opportunities

Accessibility of industrial inventory: accessibility of inventory also
determinesthe business opportunities as it comes to a decision the
level of future production.
Chance of Export: Export potentiality is an imperative criterion for
measuringcompetence of a particular industry.
Congregation information regarding the tentative developed
industry: Anentrepreneur is probable to take a judgment about the
incorporation of particularindustrial unit after forcefully the process of
identifying business opportunities.
Ease of use of Internal Resources: Ease of use of valuable break
andsufficient rate of return stimulate entrepreneur to embark on
entrepreneurialactivity but against with the condition that he has to
have some seed capital of hisown.
Form of External support: Recognition of business opportunity also
involvesthe marking of sources from which financial and other
facilities are predictable tocome.
Height of risk in the business: There are dissimilar types of risk
usually drawnin in a particular business. These risks are technological
risks, financial risks,societal risks and ecological risks.
Level of inner Demand: An entrepreneur should endeavor to assess
theblueprint of inner demand of anticipated product or industry in
which he isplanning to engross himself.
Psychoanalysis of existing units performance: Objective analysis
ofperformance of accessible units is to be commenced to make certain
success indetection of business opportunities.
Sources of new ideas: Entrepreneurs frequently use the following
sources of ideas:
1. Consumers– the potential consumer should be the final focal point
of ideas for the entrepreneurs. The attention to inputs from potential
consumers can take the form of informally monitoring potential ideas
or needs or formally arranging for consumers to have an opportunity

to express their concerns. Care needs to be taken to ensure that the
new idea or the needs represents a large enough market to support a
new venture.
2. Existing Companies– with the help of an established formal
methods potential entrepreneurs and intrapreneurs can evaluate
competitive products & services on the market which may result in
new and more market appealing products and services.
3. Distribution channels– members of the distribution channels are
familiar with the needs of the market and hence can prove to be
excellent sources of new ideas. Not only do the channel members help
in finding out unmet or partially met demands leading to new
products and services, they also help in marketing the offerings so
developed.
4. Government– it can be a source of new product ideas in two ways
firstly, the patent office files contain numerous product possibilities
that can assist entrepreneurs in obtaining specific product information,
and secondly, response to government regulations can come in the
form of new product ideas.
5. Research & development– Entrepreneur’s own R&D is the largest
source of new idea. A formal and well-equipped research and
development department enables the entrepreneur to conceive and
develop successful new product ideas.
Methods of generating new ideas
Even with the wide variety of sources available, coming up with an
idea to serve as the basis for the new venture can still be a difficult
problem. The entrepreneur can use several methods to help generate
and test new ideas, including focus groups, brain storming and
problem inventory analysis.
Focus groups
Group of individuals providing information in a structured format is
called a focus group. The group of 8 to 14 participants is simulated by
comments form other group members in creatively conceptualizing
and developing new product idea to fulfill a market need.
Brainstorming
A group method of obtaining new ideas and solutions is called
brainstorming. The brainstorming method for generating new ideas is

based on the fact that people can be stimulated to greater creativity by
meeting with others an d participating with organized group
experiences. Although most of the ideas generated from the group
have no basis for further development, often a good idea emerges.
Problem inventory analysis
Problem inventory analysis uses individuals in a manner that is
analogous to focus groups to generate new product ideas. However
instead of generating new ideas themselves, consumers are provided
with a list of problems in a general product category. They are then
asked to identify and discuss products in this category that have the
particular problem. This method is often effective since it is easier to
relate known products to suggested problems and arrive at a new
product idea then to generate an entirely new idea by itself.
CREATIVE PROBLEM SOLVING
Creative problem solving is a method for obtaining new ideas
focusing on the parameters.
Brainstorming
The first technique, brainstorming, is probably the most well known
and widely used for both creative problem solving and idea
generation. It is an unstructured process for generating all possible
ideas about a problem within a limited time frame through the
spontaneous contribution of participants. All ideas, no matter how
illogical, must be recorded, with participants prohibited from
criticizing or evaluating during the brainstorming session.
Reverse brainstorming
Similar to brainstorming, but criticism is allowed and encouraged as a
way to bring out possible problems with the ideas.
Synectics
Synectics is a creative process that forces individuals to solve
problems through one of four analogy mechanisms: personal, direct,
symbolic and fantasy. This forces participants to consciously apply
preconscious mechanisms through the use of analogies in order to
solve problems.
Gordon method
Gordon method is a method of developing new ideas when the
individuals are unaware of the problem. In this method the

entrepreneur starts by mentioning a general concept associated with
the problem. The group responds with expressing a number of ideas.
Checklist method
Developing a new idea through a list of related issues is checklist
method of problem solving.
Free association method
Developing a new idea through a chain of word association is free
association method of problem.
Forced relationship
Forced relationship is the process of forcing relationship among some
product combination. It is technique that asks questions about objects
or ideas in an effort to develop a new idea.
Collective notebook method
It is method in which ideas are generated by group members regularly
recording ideas.
Heuristics
It is method of developing a new idea through a thought process
progression.
Scientific method
This is a more structured method of problem solving, including
principles and rules for concept formation, making observations and
experiments, and finally validating the hypothesis.
Value analysis
Value analysis is developing a new idea by evaluating the worth of
aspects of ideas.
Attribute listing
This is an idea finding technique that requires the entrepreneur to list
the attributes of an item or problem and then look at each from a
variety of viewpoints.
Matrix charting
Matrix charting is a systematic method of searching for new
opportunities by listing important elements for the product area along
two axis of chart and then asking questions regarding each of these
elements.
Big dream approach

Developing a new idea by thinking about constraints is big-dream
approach of problem solving.
Parameter analysis
Parameter analysis is developing a new idea by focusing on parameter
identification and creative synthesis.
CREATIVITY AND ENTREPRENEURSHIP
Creativity eliminates the limits to the mindset and skill set of an
investor.However, a lot of people associate creativity with lack of
restraint and believe it can cause chaos. Conversely, leadership is all
about control and order.
As such, entrepreneurship and creativity form a perfect combination.
It no longer takes number-crunching skills and practicality to run a
successful business.Over time, creativity has become an integral
component of good business acumen. Lack of creativity could easily
drag your business into the stagnation mode.Here is why creativity is
critical to entrepreneurs.
High overall success: There is a misconception that people only needs
intelligence to achieve everything they need in life.However, it takes
time for aspiring entrepreneurs to realize that creativity plays an
integral role as well.
Unfortunately, a lot of learning institutions stress more on intelligence
than creative thinking. It could perhaps be because intellectual
knowledge is measurable whereas creativity can be challenging to
spot. Nonetheless, dynamics are changing, and entrepreneurs are
beginning to realize the importance of bringing creative people on
board. Creative workers can be a game changer in your company if
you harness and shape their skills adequately.
Increase productivity:Creativity allows an entrepreneur to disconnect
from the accustomed and move into uncharted territories with an aim
to discern unique and useful solutions.It has, therefore, become
essential for both leaders and employees to develop creative skills.
Entrepreneurs are providing the necessary technological resources
such as visual collaboration, which is often confused with video
conferencing to help their workers discover innovative solutions and
ideas.In fact, this is an extremely cost-effective strategy to increase

workplace productivity. Innovation and creativity bring an
entrepreneur to the success path.
Exploit employee potential: You are probably utilizing only half of
your employee’s potential by not encouraging workplace
creativity.Fortunately, entrepreneurs increasingly realize the ocean of
creative ideas that remain untapped and dormant.
Tapping all these opportunities can result in improved financial
strategies, increased profitability, and quick decision making.
Creativity also enables an enterprise to stay ahead of the curve.
Transcend boundaries: Creativity enables entrepreneurs to find some
of the path-breaking discoveries.As such, it’s essential to allow
collisions and blur to take place to transcend boundaries set by
disciplines.That way, it’s easier for an entrepreneur to get new
perspectives towards solving a financial or operational problem.
Creativity lets an entrepreneur connect distinct aspects and extrapolate
feasible solutions from unrelated concepts.
Encourage critical thinking: Creativity is slowly turning out to be
one of the best ways to alleviate problems plaguing today’s
enterprises.Problem-solving works best when coupled with highly
disciplined and focused thinking. Entrepreneurs can think in either
divergent or convergent thinking mode.Convergent thinking involves
in-depth analysis and enables an entrepreneur to find the most feasible
solution to a managerial or financial problem.
It allows entrepreneurs to use various data sources such as accounting
software and computer systems.In contrast, divergent thinking
encourages creativity by enabling business owners to explore possible
solutions for the same problem.
While entrepreneurs can combine both thinking modes, divergent
thinking ensures an enterprise gets the best resolution.
Foster innovation: Manufacturers create unique products to not only
meet customer expectations but exceed them as well.As such,
entrepreneurs need to be cautious to ensure their products are relevant
and useful to the users.While it may be hard to spot this from the
beginning, things start to get more evident as your idea turns into a
reality.

In fact, this is the time an entrepreneur begins to realize how innovation
and invention differ. The invention refers to a new, unique concept while
innovation is an idea which is as unique and useful as the original one.
You need to be creative and view an idea differently to be innovative. That
way, it’s easier to turn a concept into a reality.
Product planning and development process
New product development is a process of taking a product or service from
conception to market.The process sets out a series of stages that new
products typically go through, beginning with ideation and concept
generation, and ending with the product's introduction to the
market.Occasionally, some of the stages overlap or vary depending on the
nature of the business.
Key stages in the process of product or service development
The process involves eight key stages:
1. Idea generation – brainstorming and coming up with innovative new
ideas. See generating ideas for new products and services.
2. Idea evaluation - filtering out any ideas not worth taking forward.
See screening new product or service idea.
. Concept definition - considering specifications such as technical
feasibility, product design and market potential. See researching new
product and service ideas.
4. Strategic analysis - ensuring your ideas fit into your business' strategic
plans and determining the demand, the costs and the profit margin.
5. Product development and testing - creating a prototype product or pilot
service. See concept development and testing.
6. Market testing - modifying the product or service according to
customer, manufacturer and support organisations' feedback. This involves
deciding the best timing and process for piloting your new product or
service. See how to test the market.
7. Commercialisation – determining the pricing for your product or service
and
finalising marketing plans. See pricing your proposed service or product.
8. Product launch – a detailed launch plan can help ensure smooth
introduction to market.

Unit III
Entrepreneurial Process
People are always asking for a list of fundamentals they can use to
start their own businesses. From your business type to your business
model to your physical location, there are so many variables it’s not
easy to come up with a list that will work “exactly so” for everybody.
With that being said, here are our seven steps to starting your own
business. The key, regardless of what type of business you’re starting,
is to be flexible!
1. Conduct a personal evaluation
“Know yourself, and work in a job that caters to your strengths. This
knowledge will make you happier.” – Sabrina Parsons
Begin by taking stock of yourself and your situation:
Why do you want to start a business? Is it money, freedom, creativity,
or some other reason?
What skills do you have?
What industries do you know about?
Would you want to provide a service or a product?
What do you like to do?
How much capital do you have to risk?
Will it be a full-time or a part-time venture?
Your answers to these types of questions will help you narrow your
focus.
This step is not supposed to dissuade you from starting your own
business. Rather, it’s here to get you thinking and planning. In order
to start a successful business, passion alone isn’t enough.

The entire better if you can enter a market you like and that you know
well. As you get started, your business will likely dominate your life
so make sure that what you’re doing is stimulating and not dull.
You’re going to be in it for the long-haul.
2. Analyze your industry
“The more you know about your industry, the more advantage
and protection you will have.” – Tim Berry
Once you decide on a business that fits your goals and lifestyle, you
need to evaluate your idea. Who will buy your product or service?
Who will your competitors be? At this stage you also need to figure
out how much money you will need to get started.
Your “personal evaluation” was as much a reality check as a prompt
to get you thinking. The same thing applies when it comes to
researching your business and the industry you’d like to go into.
There are a number of ways you can do this, including performing
general Google searches, going out and speaking to people already
working in that industry, reading books by people from the industry,
researching key people, reading relevant news sites and industry
magazines and taking a class or two (if this is possible).
If you don’t have time to perform the research or would like a second
opinion, there are people you can go to for help, like government
departments and your local SBDC.

In order to identify how attractive your prospective market really is
(your own desires aside for the moment), there are a few things you
should consider:
How urgently do people need the thing you’re selling or offering
right now?
What’s the market size like? Are there already a lot of people paying
for this thing? For example, the demand for “traditional signwriting
classes” is almost non-existent.
How easy is it (and how much will it cost you) to acquire a
customer? If you’re a lead generation business, this may require a
significantly larger investment that says a coffee shop.
How much money and effort will it cost to deliver the value you
would like to be offering?
How long will it take to get to market? A month? A year? Three
years?
What size up-front investment will you need before you can begin?
Will your business continue to be relevant as time passes? A
business that repairs exclusively iPhone 5 screens will only remain
relevant so long as the iPhone 5 sticks around. If your business is only
relevant for a specific period of time, you will also want to consider
your future plans.
3. Make it legal
Realistically speaking, registering your business as a business is the
first step toward making it real. However, as with the personal
evaluation, take your time to get to know the pros and cons of
different business formations.
If at all possible, work with an attorney to iron out the details. This
is not an area you want to get wrong. You will also need to get the
proper business licenses and permits. Depending upon the business,
there may be city, county, or state regulations as well as permits and
licenses to deal with. This is also the time to check into any insurance
you may need for the business and to find a good accountant.
Types of business formations include:
Sole proprietorship
Partnership
Corporation
Limited Liability Company (LLC)
Spend some time getting to know the pros and cons of each business
formation. If you need help, we’ve got a full guide on Legal Entities,
Licenses and Permits.
While incorporating can be expensive, it’s well worth the money. A
corporation becomes a separate entity that is legally responsible for
the business. If something goes wrong, you cannot be held personally
liable.
Other things you will need to do include deciding on a business
name and researching availability for that name.
4. Start the planning process
“Our goals can only be reached through the vehicle of a plan, in
which we must fervently believe, and upon which we must vigorously
act. There is no other route to success.”
– Pablo Picasso
If you will be seeking outside financing, a business plan is a
necessity. But, even if you are going to finance the venture yourself, a
business plan will help you figure out how much money you will need
in order to get started; what needs to get done when, and where you
are headed.
In the simplest terms, a business plan is a roadmap—something you
will use to help you chart your progress and that will outline
the things you need to do in order to goals. Rather than thinking of a
business plan as a hefty document that you’ll only use once (perhaps
to obtain a loan from a bank), think of it as a way to formalize your
intentions.
While you will potentially use your business plan as part of your pitch
to investors and banks, or use it to attract potential partners and board
members, you will primarily use it to define your strategy, tactics, and
specific activities for execution, including key dates, deadlines and
budgets, and cash flow.
In fact, the business plan does not have to be a formal document at all
if you don’t need to present your plan to outsiders. Instead, your plan
can follow a lean planning process that involves creating a
pitch, forecasting your key business numbers, outlining key

milestones you hope to achieve, and regular progress checks where
you review and revise your plan.
If you aren’t presenting to investors, your pitch is not the traditional
pitch presentation, but instead a high-level overview of who you are,
the problem you are solving, your solution to the problem, your target
market, and the key tactics you will use to achieve your goals.
Even if you do not think you need a business plan, you should go
through the planning process anyway. The process of doing so will
help to uncover any holes or areas that have you have not thought
through well enough. If you do need to write a formal business plan
document, you should follow the outline below.
The standard business plan comprises nine parts, including:
 The Executive Summary
 Company Overview
 Products and Services
 Target Market
 Marketing and Sales Plan
 Milestones and Metrics
 Management Team
 Financial Plan
 Appendix
If you would like detailed information on how to write a business
plan to present to others, there are plenty of online resources,
including our own comprehensive guide.
You will also find hundreds of sample plans for specific industries on
this very website. Use them at your leisure but be prepared to adapt
them to suit your precise needs. No two businesses are the same
5. Get financed
Depending on the size of your venture, you may need to seek
financing from an “angel” or from a venture capital firm. Most small
businesses begin with private financing from credit cards, personal
loans, help from the family, and so on.
As a rule, besides your start-up costs you should also have at least
three months’ worth of your family’s budget in the bank. In order to
finance your company, you will need to match the company’s needs
to the appropriate financing option.
The main types of investment and lending options include:
 Venture capital
 Angel investment (similar to venture capital)
 Commercial (banks)
 The Small Business Administration (SBA)
 Accounts receivable specialists
 Friends and family
6. Set up shop
You’ve done it—or, just about. Your business plan has been laid out,
the money is in the bank, and you’re ready to go.
You’ve got a long list of things you need to do: Find a location.
Negotiate leases. Buy inventory. Get the phones installed. Have
stationery printed. Hire staff. Set your prices. Throw a grand opening
party.
Each of these steps will need to be thought through carefully.
Your business location will dictate the type of customer you attract,
what types of promotions you can run, and how long it will take you
to grow. While a great location won’t necessarily guarantee your
success, a bad location will almost always guarantee failure.
As you’re thinking about where you want to set up shop (including
the city and state), consider the following:
Price—Can you realistically afford to be where you want to be? If
not, or if you’re cutting it fine, keep looking.
Visibility—Will people easily be able to find you? Will they see your
promotions and offers? Are you in the center of town or further out?
How will this affect you?
Access to parking or public transportation—Can people easily find
you from available parking options and transportation routes? If they
have to look too hard, they may give up.
Distribution of competitors—Are there many competitors close to
you? If so, this may be a sign that the location is premium for the
clientele you wish to attract. It may also mean you do no business.
Consider carefully how you wish to approach this type of situation.
Local, city and state rules and regulations—Look into regulations, as
areas may be more stringent than others. Ensure there are no

restrictions that will limit your operations or that will act as barriers to
your store.
Your marketing will set the stage for the future of your store. It will set
expectations, generate hype (if done well), bring business in from day one
and ensure that people know where you are and what they can expect from
you.
Your store’s layout, design and placement of your products will decide not
only the overall atmosphere of the store, but what products people see and
buy. Consider the areas you want well lit; how you will display products
(if necessary); what various colors will make people feel, and how people
will move through your store.
There are reams of literature on why we buy what we do, all of it
fascinating and much of it informative. Begin thinking about how you
shop—this will get you to think more critically about your own store.
Consider: placing products low on shelves will mean that people are
unlikely to see them and therefore unlikely to buy them, whereas placing
them at eye-level will mean they’re seen first and are therefore probably
more likely to be purchased.
Your choice of products and how you decide to price them will create a
reputation. Rather than stock everything of a similar price range from one
or two catalogues, consider only choosing those items that will create the
feel you want to become known for.
If you’re a service business, build your services in a similar manner,
considering your different clientele and the value they will get from the
different options you have on offer. If a very affordable package will
cheapen your brand, consider excluding it. If a pricier option will limit
your clientele too drastically, maybe cut back on some of the services
included.
7. Trial and error
Whether you’re starting your first or your third business, expect to make
mistakes. This is natural and so long as you learn from them, also
beneficial.
If you do not make mistakes, you do not learn what to do less of and
equally, what to do more of. Be open-minded and creative, adapt, look for
opportunities, and above all, have fun!
The great thing about owning your own business is that you get to decide
what you want to do and what direction you want to grow in.

UNIT 3
Protecting Ideas and Legal issues for the entrepreneur
Patents:
Patent is a grants holder protection from others making, using, or
selling a similar idea. A patent is a contract between the government
and an inventor. In exchange for disclosure of the invention, the
government grants the inventor exclusivity regarding the invention for
a specified amount of time. At the end of this time, the government
publishes the invention and it becomes part of the public domain.
Trademarks
To all my business owners, franchisors and entrepreneurs, here is your
opportunity to stake your claim.
Definition
“A symbol, word, phrase, logo, or combination of these that legally
distinguishes one company's product from any others. Any
infringement on a trademark is illegal and therefore grounds for the
company owning the trademark to sue the infringing party.”
To add to the perplexity, there are four different types of trademarks.
Why have just one when you can quadruple the process? While it may
feel like that to entrepreneurs, they each serve a different (and valid)
purpose.
The four types are: Service Marks, Trademarks, Certification Marks
and Collective Marks.
 Service Mark: a word, name, symbol or design identifying
services or intangible activities performed by a person for the purpose
of distinguishing their services from others;
 Word Mark: text based mark identifying a company,
organization, product, service or brand;
 Certification Marks: mark used in commerce by a person other
than its owner. They are usually owned by a trade association or
commercial group;
 Collective Marks: typically owned by an organization and used
by its members to identify themselves as to level of quality,
geographical origin or additional characteristics designed by the
organization .

Many companies utilize multiple trademarks in their business. For
example, Nike has incorporated several different trademarks into their
branding. The Nike swoosh is a service mark. The tagline, “Just do
it,” is a Word Mark.
When starting out the most important mark to register is the Word
Mark.
Nuances
The process of acquiring a trademark can take 8-12 months. The
process of applying isn’t as time intensive as the approval process, so
I always encourage business owners to apply sooner as opposed to
later.
If you are looking to franchise in the future, check out on the
additional benefit they offer to prospective franchisees.
Copyrights
To all my writers, musicians, manuscript makers and artists, claim
what’s yours through a copyright!
Definition
“The ownership of intellectual property by the item's creator.
Copyright law gives creators of original ideas, art, etc. the exclusive
right to further develop them for a given amount of time, at which
point the copyrighted item becomes public domain.”
Copyrights have a more narrow scope than their legal counterparts
listed here. When thinking about copyrights, think works written (or
typed) on a piece of paper, artwork, or songs. This really applies more
to your writers or artists.
Copyrights take about 3-4 months to process.
Licensing Agreement
To my software developers, musicians and businesses with extensive
brand equity (such as Disney), licensing is your opportunity to lease
your assets, knowledge or brand.
Definition
“This term refers to a written agreement entered into by the
contractual owner of a property or activity giving permission to
another to use that property or engage in an activity in relation to that
property. The property involved in a licensing agreement can be real,

personal or intellectual. Almost always, there will be some
consideration exchanged between the licensor and the licensee.
Bottom line, you are renting out your intellectual property. You own
all the rights to a product, but give permission for others to use it for a
licensing fee. Let’s look at this through some examples.
Software is one of the easiest places. Odds are you have Microsoft
Word on your computer. Microsoft owns that program, but you paid
for the right to use it. What’s cool about licensing is that the
individual user does not diminish the value of the product. What this
means is that two adjacent businesses can both license this product
and the value is the same. Sometimes people try to license business
models. In that instance, if a fellow licensee was next door, the
product would be less valuable.
Disney has an interesting play in the licensing space, in addition to
several other large brands. They work with apparel companies and
publishers to create supplemental products (t-shirts, books, costumes
and more) featuring their characters.
Additionally, musicians grant rights to use their songs for movies or
other endeavors through licensing.
Licensing is the best way to maintain your ownership of the
intellectual property under a consensual agreement while also
generating revenue.
Definition
“A government license that gives the holder exclusive rights to a
process, design or new invention for a designated period of time.
Applications for patents are usually handled by a government agency.
In the U.S., the United States Patent and Trademark Office handles
application and documentation.”
That’s all fine and dandy, but what does it all mean for you? First,
patents apply to tangible inventions that are father developed from
idea stage. Despite the teachings of snake oil salesmen, not everything
can be patented.
Additionally, mere “ideas” don’t make it far though the process.
While you can apply without a prototype, you must be able to
describe how one would make and use it. Illustrations and rendering
of the product help immensely.

Patents are processed through the United States Patent and Trademark
Office. This can take anywhere from a year to several years.
Unfortunately, there’s not much you can do to predict the time frame.
The biggest trend in patents right now is in the technology space with
powerhouses such as Google. They have produced several patents
recently around the buy button and website layouts.
Nuances
Patents are only valid for 14-20 years. Once your patent expires, your
protection is gone. And, let’s review this “protection.” While no one
is allowed to profit from your specific invention, it doesn’t limit
reverse engineering.
The other nuance is that it takes a special lawyer to address patents.
More often than not, you find patent lawyers who have a background
in science and technology. This is because they have to be bilingual,
being an expert in both your industry (science, technology etc.) and
legalese.
Trade Secrets
Most companies have certain trade secrets, which may include
customer lists, customer profiles, distribution methods, and sales
methods to name a few. Your business should require employees to
execute confidentiality agreements to protect trade secrets.
Additionally, vendors who are performing work for your business
sign Non-Disclosure Agreements (“NDA”) prior to receiving such
information.
Conclusion
Patents, trademarks, copyrights and licensing are great options to
protect your intellectual property. Many of them are also essential for
growing businesses, creating additional value and giving you the
ability to control your name and brand.
If you are looking to apply for trademarks, copyrights or licensing
your intellectual property, let me help you along your path. As for
patents, I am happy to help connect you to the right legal partner.
Preparation of a Business Plan
Your company seeking financial assistance for implementation of its
business idea is required to prepare a Project Report covering certain
important aspects of the project as detailed below:

 Promoters background/experience
 Product with capacity to be built up and processes involved
 Project location
 Cost of the Project and Means of financing thereof
 Availability of utilities
 Technical arrangements
 Market Prospects and Selling arrangements
 Environmental aspects
 Profitability projections and Cash flows for the entire repayment
period of financial assistance
NEED FOR A BUSINESS PLAN
Before starting any enterprise, your client has to observe, analyse and
learn a lot. Youmust realise that conducting a business involves a
complex interplay of many events andforces, which should be
understood beforehand by anyone willing to start and operate
abusiness.The entrepreneur has to internalise and develop various
desired competencies. Scanningof analysing the environment might
bring out several business opportunities to choosefrom. This choice
can be made on several counts like current demand and likely
futurescenario; the aptitude, knowledge and skills of the entrepreneur;
available resources, etc.
Thereafter, the information on product range, processes involved,
various requirementsof key inputs like technology, machinery,
materials, manpower, etc. has to be gatheredand a detailed study of
the market needs to be undertaken. This enables the
potentialentrepreneur to be equipped for a successful launch of the
enterprise. However, beforethis, all the information gathered has to be
arranged in a typical format, often called
Project Report or Business Plan. In this section, we shall look at the
inputs that must go
into any Business Plan or a Project Report.Even the simplest and
smallest business venture needs meticulous planning on the partof the
entrepreneur. Whether your clients intend to be household artisans,
small vendors,service providers, or petty shopkeepers they would
need to plan their activities beforelaunching the business. It is
generally found that the small entrepreneurs often do notrecord their
business plans and thus are not able to monitor their own progress. In
theprocess, mistakes are repeated and the entrepreneur remains at loss
to understand the realproblems. Therefore, you must emphasise upon
your clients that they must prepare a
Business Plan so as to take a firm view of the prospective business
and to decide on aconcrete plan of action. This will help in
monitoring, analysing and assessing the likelyresults of the enterprise
over a period of time.
PREPARING BUSINESS PLAN
We should be very clear that the entrepreneur himself is the best
person to prepare thebusiness plan. For every person wanting to
venture into business, preparing a businessplan is an opportunity to
test his/her own knowledge and perceptions about the chosenactivity.
You would often find with your clients that the: prospective
entrepreneur maynot be thorough with his/her ideas. It might,
therefore, be useful to gather moreinformation and utilize more time
before taking the plunge into the world of business.
But the benefits attached with the process far outweigh the efforts. So
let your clientsmake sincere attempts to prepare business plan, so as to
reap the rewards at later stages.
EXIT STRATEGY
A. Every entrepreneur that starts a new venture should think about an
exit strategy.
B. Exit strategies include:
1. An initial public offering (IPO)
2. Private sale of stock
3. Succession by a family member or non-family member
4. Merger with another company
5. Liquidation of the company
6. Sale of the company to employees (an ESOP) or to an external
source
C. Each of the exit strategies has its advantages and disadvantages.
Exit Strategy
A business exit strategy is an entrepreneur's strategic plan to sell his
or her ownership in a company to investors or another company.
An exit strategy gives a business owner a way to reduce or liquidate

his stake in a business and, if thebusiness is successful, make a
substantial profit.
Succession of Business
Transferring your business to family members or other insiders, in an
orderly and successful manager, may be the toughest management
challenge you face in the life of the business. Not only must you
choose your successor wisely, you must thoroughly prepare him or
her while confronting and resolving conflicting goals and agendas.
Plus, you need to structure the transfer to minimize the tax impact on
the business and your family.
You've invested a great deal of time, money and energy into your
business. As a result, you probably want to see the business continue
and flourish once you leave the helm. This is especially likely if most
of your family wealth is tied to the business, in one form or another.
However, simply wishing and wanting a successful transition to
family members or other insiders isn't enough because orchestrating a
smooth succession can be the ultimate management challenge. On top
of these "people" issues, you must also consider business, tax, and
estate issues when planning for the succession of both management
and ownership.
Any transition of an ongoing business must preserve the continuity of
leadership. Therefore, it is critical that you view succession of
ownership and management as a planned process, rather than as one-
time event. Even though you (and your successor) might like to skip
the difficulties associated with implementing a transition plan, you
can't simply hand the keys to your successor and walk away--at least
not if you want your business to continue. Succession is a process
requiring planning, teamwork, and constant re-evaluation.
As we've stated, simply wishing and wanted to pass your business to
the next generation isn't enough. In fact, barely 30 percent of family
businesses survive into the second generation and fewer than 15
percent of them endure into the third. This is a sad fact, not only for
the families, but for the nation's economic health, because much of
our economy is made up of small, family-owned businesses. If the
business of succession is not done by process (through planning), it

will be done by crisis (a failure to plan), with perhaps disastrous
results.
A typical succession plan has two elements. Each element must be
managed separately:
 Transfer of power. You transfer control over the business's
operation to the individual (or individual's) that you feel are the most
suited to succeed you.
 The transfer of assets. You transfer the wealth concentrated in
the business to designated family members. Those benefiting from a
transfer of wealth may be a different or larger group than the person
or persons who will be assuming power.
Planning Helps Avoid Pitfalls in Transferring Power
The family business is affected by all the issues that face by any type
of business, such as technology, laws, climate, competitors, economic
trends, and employees are among these influences. In addition, the
family business is influenced by anything that influences the family
itself, such as the relative health of its members, their various interests
and skill levels, their individual marital status, and the level of
business participation of each individual.
Managing a transfer of power while balancing the internal and
external environmental influences of the business is a juggling act. If
the founder is reluctant to give up control and/or the successor is not
well prepared to accept it, the transfer can be a challenge that would
daunt the most skilled psychiatric social worker or business
consultant.
Fortunately, most family business people are professionals who
manage their companies to compete effectively in our global
marketplace. They don't have time to dwell on petty jealousies and
family squabbles. However, that doesn't mean that you should not
consider carefully the factors surrounding a transfer of power
The major issues confronting a family business owner seeking to
transfer power to successors are:
 selecting a successor;
 managing inter-generational conflict, different agendas and
different goals;
 providing adequate training for the successor; and

 timing the transition.
Tips for Selecting a Successor
The business successor is often selected by default. Most family
businesses will have one member of the next generation who is more
active, qualified, and interested in the business than his or her
siblings. Frequently, the founder has already spent a great deal of time
grooming the successor-apparent or the successor has soaked up much
of the necessary knowledge on his or her own. In this case, the
challenge of succession planning to to find ways to ensure equitable
treatment for the non-participating family members, be they the
spouse or siblings.
The other side of the coin is the under-prepared, disinterested or lazy
successor-elect. Sometimes the founder is willing and eager to give
the business to his daughter, but she'd rather be a marine biologist. Or,
one child wants to be the boss, just so he can get a classy company car
and play golf every day. Or, perhaps a child is interested and willing,
but hopelessly unqualified for the task.
Between these extremes are the majority of family business
successions. Able founders need to pass along a hard-earned creation
to able successors who have worked hard to become prepared to take
on the task. There will be the usual number of differences of opinion
and approach commonly found between generations and between co-
workers of the same generation. These can and will be worked out
mutually over time to the benefit of the individuals, the family and the
business. Planning and communication are the tools these successful
teams must use consistently.
If succession has not already been determined by interest, proximity,
or birth order, a group effort in choosing and grooming an individual
is one way to proceed. Key employees who are not family members
can often be recruited for a transition team. If your valued, long-time
employees participate in the selection and initiation of a successor, the
entire team will benefit over the long run. Involving key employees is
a good way to retain them, and retaining them is essential for
continuity and credibility in dealing with outside sources such as
banks and suppliers.

If there is competition between your children for the position, a
decision to divide the power between them is not likely to be
successful. Ownership may be divided, but management should be
clearly delineated. Often ownership can be split into passive and
active shares, giving the active successor the necessary control over
the business while providing an equal economic benefit to the inactive
shareholders. In some cases the business can be divided along
functional lines, so that different family members can assume control
over well-defined functions or business units.
Navigating Intergenerational Conflict
Conflict between the founder of a family business and his or her
successor is a matter of degree. It's normal for some intergenerational
conflict to exist. However, in the worst cases, a "sandwich
generation" effect may be visited upon the middle layer in a family
business.
Example
A powerful founder's successor is often responsible to the generations
that precede him/her and for the generations that succeed him/her. In
these days of longer life spans, b the time #1 daughter takes over the
business, #1 grandson is already coveting that position. And the
founder may be more favorably inclined toward the grandchild since
he feels like less of a threat to the founding father.
The child who accepts this should be a well trained manager of
himself, as well as others. Then he or she will be able to manage
around the unbusinesslike emotional upheavals that frequently are
generated in power struggles. Leadership and communication skills
will win the day if applied consistently. A true understanding of the
feelings and motivations of the founder will enable the successor to
deal rationally and effectively with them. After all, the founder spent
his or her entire life building the firm and sees it as an extension of his
or her self
bankruptcy Reasons of failure of business plan
Choosing a business that isn't very profitable. Even though you
generate lots of activity, the profits never materialize to the extent
necessary to sustain an on-going company.

Inadequate cash reserves. If you don't have enough cash to carry
you through the first six months or so before the business starts
making money, your prospects for Success are not good. Consider
both business and personal living expenses when determining how
much cash you will need.
Failure to clearly define and understand your market, your
customers, and your customers' buying habits. Who are your
customers? You should be able to clearly identify them in one or two
sentences. How are you going to reach them? Is your product or
service seasonal? What will you do in the off-season? How loyal are
your potential customers to their current supplier? Do customers keep
coming back or do they just purchase from you one time? Does it take
a long time to close a sale or are your customers more driven by
impulse buying?
Failure to price your product or service correctly. You must
clearly define your pricing strategy. You can be the cheapest or you
can be the best, but if you try to do both, you'll fail.
Failure to adequately anticipate cash flow. When you are just
starting out, suppliers require quick payment for inventory
(sometimes even COD). If you sell your products on credit, the time
between making the sale and getting paid can be months. This two-
way tug at your cash can pull you down if you fail to plan for it.
Failure to anticipate or react to competition, technology, or other
changes in the marketplace. It is dangerous to assume that what you
have done in the past will always work. Challenge the factors that led
to your Success. Do you still do things the same way despite new
market demands and changing times? What is your competition doing
differently? What new technology is available? Be open to new ideas.
Experiment. Those who fail to do this end up becoming pawns to
those who do.
Overgeneralization. Trying to do everything for everyone is a sure
road to ruin. Spreading yourself too thin diminishes quality. The
market pays excellent rewards for excellent results, average rewards
for average results, and below average rewards for below average
results.

Overdependence on a single customer. At first, it looks great. But
then you realize you are at their mercy. Whenever you have one
customer so big that losing them would mean closing up shop, watch
out. Having a large base of small customers is much preferred.
Uncontrolled growth. Slow and steady wins every time. Dependable,
predictable growth is vastly superior to spurts and jumps in volume.
It's hard to believe that too much business can destroy you, but the
textbooks are full of case studies. Going after all the business you can
get drains your cash and actually reduces overall profitability. You
may incur significant up-front costs to finance large inventories to
meet new customer demand. Don't leverage yourself so far that if the
economy stumbles, you'll be unable to pay back your loans. When
you go after it all, you usually become less selective about customers
and products, both of which drain profits from your company.
Believing you can do everything yourself. One of the biggest
challenges for entrepreneurs is to let go. Let go of the attitude that you
must have hands-on control of all aspects of your business. Let go of
the belief that only you can make decisions. Concentrate on the most
important problems or issues facing your company. Let others help
you out. Give your people responsibility and authority.
Putting up with inadequate management. A common problem
faced by Successful companies is growing beyond management
resources or skills. As the company grows, you may surpass certain
individuals' ability to manage and plan. If a change becomes
necessary, don't lower your standards just to fill vacant positions or to
accommodate someone within your organization. Decide on the skills
necessary for the position and insist the individual has them.
So, the founder's attitude, ability to be objective, willingness to
bring in needed help, and share power are all crucial to
success. "Most startups make the mistake of falling in love with their
product or service," says Shukla. "Ultimately, it is this lack of self-
criticism that causes many companies, startups and their more mature
counterparts, to fail. Startups suffer this fate more often because there
are more dreamers than doers."
Other reasons why businesses fail in their early years include: poor
business location, poor customer service, unqualified/untrained

employees, fraud, lack of a proper business plan, and failure to seek
outside professional advice.
While poor management is cited most frequently as the reason
businesses fail, inadequate or ill-timed financing is a close
second. Whether you're starting a business or expanding one,
sufficient ready capital is essential. It is not, however, enough to
simply have sufficient financing; knowledge and planning are
required to manage it well. These qualities ensure that entrepreneurs
avoid common mistakes like securing the wrong type of financing,
miscalculating the amount required, or underestimating the cost of
borrowing money.
Causes of success and failure of entrepreneur:
An entrepreneur may sometime become successful and sometime
becomes failure. There are some causes of such success and failure.
They are noted below:
1. Selection of business: It is an important aspect. That means an
entrepreneur has to determine what type business he is going to start.
Form various points of view the feasibility of the business should be
tested.
2. Proper planning: Proper planning me s also important. For
planning, planning premises like political, economic, social premised
should be considered first. The steps of planning should be followed
properly.
3. Initial capital: if the initial capitals are not an optimal level the
organization would fall. So whether the enterprise is big or small the
initial capital should be sufficient enough.
4. Determination o0f market demand: Through research the
demand in the market should be identified. Both for long term and
short term it should be considered.
5. Marketing of product: If the promotion policy, channel of
destitution, transportation is not good the enterprise would fall.
6. Education and experience: One of the important tasks of the
entrepreneurs is to select right person for the right post because the
success of an enterprise depends on the right selection of employees.
7. Joint initiative: One may have much money and another may
have more merit. Through joint initiative it can be balanced. But

sometime for joint initiative misunderstanding arise, or sometimes
corruption occur which may result in fall of enterprise.
8. Employment: Recruitment and appointment should be properly
done. Those who have specialized skill should be appointed to that
specialized job. Inefficient, corrupted employees may be responsible
for fall of business.
9. Location of business: Site selection is an important factor.
While starting a new business, an entrepreneur should think about the
location of the business. In this case, many factors should be
considered such as availability of raw materials, proper
communication system, availability of labor, marketing facilities and
so on.
10. Qualities of management: The management must have a
minimum quality to success otherwise it would fall.
These are the common causes for which one enterprise may become
successful and another may fall

UNIT 4
Project Management
A project is temporary in that it has a defined beginning and end in
time, and therefore defined scope and resources.
And a project is unique in that it is not a routine operation, but a
specific set of operations designed to accomplish a singular goal. So a
project team often includes people who don’t usually work together –
sometimes from different organizations and across multiple
geographies.
The development of software for an improved business process, the
construction of a building or bridge, the relief effort after a natural
disaster, the expansion of sales into a new geographic market — all
are projects.
And all must be expertly managed to deliver the on-time, on-budget
results, learning and integration that organizations need.
Project management, then, is the application of knowledge, skills,
tools, and techniques to project activities to meet the project
requirements.
It has always been practiced informally, but began to emerge as a
distinct profession in the mid-20th century. PMI’s A Guide to the
Project Management Body of Knowledge (PMBOK® Guide) identifies
its recurring elements:
Project management processes fall into five groups:
1. Initiating
2. Planning
3. Executing
4. Monitoring and Controlling
5. Closing
Project management knowledge draws on ten areas:
1. Integration
2. Scope
3. Time
4. Cost
5. Quality
6. Procurement
7. Human resources

8. Communications
9. Risk management
10. Stakeholder management
All management is concerned with these, of course. But project
management brings a unique focus shaped by the goals, resources and
schedule of each project. The value of that focus is proved by the
rapid, worldwide growth of project management:
 as a recognized and strategic organizational competence
 as a subject for training and education
 as a career path
Generation& screening of project ideas
Identification of a new project is a complex problem. Project selection
process starts with the generation of project ideas. In order to select
the most promising project, the entrepreneur needs to generate a few
ideas about the possible project one can 6 undertake.
The project ideas as a process of identification of a project begins
with an analytical survey of the economy (also known as pre-
investment surveys). The surveys and studies will give us ideas.
Idea Generation :- Project selection process starts with the generation
of a project idea. Ideas are based on technological breakthroughs and
most of the project ideas are variants of present products or services.
To stimulate the flow of ideas, the following are helpful: SWOT
Analysis :-
SWOT is an acronym for strengths, weaknesses, opportunities and
threats. SWOT analysis represents conscious, deliberate and
systematic effort by an organisation to identify opportunities that can
be profitably exploited by it. Periodic SWOT analysis facilitates the
generation of ideas.
Operational objectives of a firm may be one or more of the following.
• Cost reduction.
• Productivity improvement.
• Increase in capacity utilisation.
• Improvement in contribution margin.
The project ideas can be generated from various internal and external
sources. These are :- • Knowledge of market, products, and services.
• Knowledge of potential customer choice.

• Emerging trends in demand for particular product.
• Scope for producing substitute product.
• Market survey & research.
• Going through Professional magazines.
• Making visits to trade and exhibitions.
• Government guidelines & policy.
• Ideas given by the experienced person.
• Ideas by own experience.
• SWOT analysis
Project analysis
It can be done through the following steps:
Technical Feasibility
 Technology and manufacturing process : Proven/new
technology, basis of selection of technology, competing technologies,
performance data of plants based on the technology, details of
licensor of technology, process flow chart and description
 Location of the Project : Vocational advantage, availability of
raw material and other utilities, infrastructure facilities, availability of
labor, environmental aspects
 Plant and Machinery : List of machinery & equipment, details
of suppliers, competitive quotations, technical & commercial
evaluation of major equipment
 Raw material, Utilities and Manpower: Details of raw materials
and suppliers, electricity and water supply, basis of manpower
estimates, details of manpower eg. managerial, supervisory,
skilled/unskilled, training needs
 Contracts : Agreement with contractors detailing on know-
how, engineering, procurement, construction, financial soundness and
experience of contractors
 Project monitoring and implementation : Mode of
implementation, details of monitoring team, detailed schedule of
implementation.
Environmental Aspects: Air, Water and Soil Pollution, list of
pollutants / Hazardous substances, their safety, handling and disposal
arrangements, compliance with national and International Standards,
Clearances and No objection certificates required and obtained etc.

Commercial Viability
 Existing and potential market demand and supply for the
proposed product in respect of volume and pattern
 Share of the proposed product of the company in the total
market through marketing strategy
 Selling price of the product and export potential, if any.
 Buy-back arrangements, if any.
Financial Appraisal
 Cost of the Project : This includes the cost of land & site
development, building, plant & machinery, technical know-how &
engineering fees, miscellaneous fixed assets, preliminary &
preoperative expenses, contingencies, margin money for working
capital. Your company is expected to submit realistic estimates and
reasonableness of the cost of the project will be examined with
reference to various factors such as implementation period, inflation,
various agreements, quotations etc.
 Means of Financing : Means of financing shall have to
conform to proper mix of share capital and debt. This includes share
capital, unsecured loans from Promoters/associates, internal accruals,
term loans, Government subsidy/grant. Reasonableness of Promoters'
contribution in the form of equity and interest-free unsecured loans, if
any, is ascertained in view of commitment to the Project.
 Profitability Projections : Past records of financial performance
of Your company will be examined. Your company needs to submit
profitability estimates, cash flow and projected balance sheet for the
project and for the Company as a whole. Based on the projections,
various financial ratios such as Debt -Equity ratio, Current ratio,
Fixed asset coverage ratio, Gross profit, Operating profit, Net profit
ratios, Internal rate of return(over the economic life of the project),
Debt Service Coverage ratio, Earning per share, Dividend payable etc.
would be worked out to ascertain financial soundness of your
Project.
Economic Viability
 Your company will have to take real value of input as against
the value accounted in financial analysis for the purpose of economic
evaluation of the project.

 Your company should carry out social cost benefit analysis as a
measure of the costs and benefits of the project to Society and the
Economy.
 Economic analysis is therefore aimed at inherent strength of the
Project to withstand international competition on its own.
The scope for scrutiny under each of these five heads would
necessarily render their careful assessment and the examination of all
possible alternative approaches. 13 The process almost invariably
involves making decision relating to technology, scale, location, costs
and benefits, time of completion (gestation period), degree of risk and
uncertainty, financial viability, organisation and management,
availability of inputs, know-how, labour etc. The detailed analysis is
set down in what is called a feasibility report.
Project Selection
There are various project selection methods practised by the modern
business organizations. These methods have different features and
characteristics. Therefore, each selection method is best for different
organizations.
Although there are many differences between these project selection
methods, usually the underlying concepts and principles are the same.
Following is an illustration of two of such methods (Benefit
Measurement and Constrained Optimization methods):
As the value of one project would need to be compared against the

other projects, you could use the benefit measurement methods. This

could include various techniques, of which the following are the most
common:
 You and your team could come up with certain criteria that you
want your ideal project objectives to meet. You could then give each
project scores based on how they rate in each of these criteria and
then choose the project with the highest score.
 When it comes to the Discounted Cash flow method, the future
value of a project is ascertained by considering the present value and
the interest earned on the money. The higher the present value of the
project, the better it would be for your organization.
 The rate of return received from the money is what is known as
the IRR. Here again, you need to be looking for a high rate of return
from the project.
The mathematical approach is commonly used for larger projects. The
constrained optimization methods require several calculations in order
to decide on whether or not a project should be rejected.
Cost-benefit analysis is used by several organizations to assist them to
make their selections. Going by this method, you would have to
consider all the positive aspects of the project which are the benefits
and then deduct the negative aspects (or the costs) from the benefits.
Based on the results you receive for different projects, you could
choose which option would be the most viable and financially
rewarding.
These benefits and costs need to be carefully considered and
quantified in order to arrive at a proper conclusion. Questions that you
may want to consider asking in the selection process are:
 Would this decision help me to increase organizational value in
the long run?
 How long will the equipment last for?
 Would I be able to cut down on costs as I go along?
In addition to these methods, you could also consider choosing based
on opportunity cost - When choosing any project, you would need to
keep in mind the profits that you would make if you decide to go
ahead with the project.

Profit optimization is therefore the ultimate goal. You need to
consider the difference between the profits of the project you are
primarily interested in and the next best alternative.
Risk analysis
The risk analysis process is what follows the Identification of Risks
procedure and is distinguished by two clear categories: Qualitative
and Quantitative Risk Analysis.
Qualitative Risk Analysis is the process during which one prioritizes
risks for further action by assessing their probability of impacting
project development.
 Risk probability and impact assessment: During this
stage every particular risk that might occur is investigated and
analyzed in relation to its plausible effects, both positive opportunities
and negative threats, on the project’s objectives (e.g. cost, schedule,
quality, performance). Each risk is defined in levels my means of an
interview, an investigation or a meeting with all related
stakeholders to document the identified results.
 Impact risk rating matrix: The documented results of
risk probability can be described in qualitative terms, such as very
high, high, neutral, low and very low. The risk rating is developed
using a matrix which represents risk scales for each of the risks. The
matrix documents the risk probability scale between no possibility
(0.0 rate) and certainty (1.0 rate), as well as the risk’s impact scale,
reflecting the severity of its influence on the project’s objective. This
matrix helps to improve the quality of the data and make the process
easier to replicate several times during the project.
 Risk categorization: In this step, risks are grouped by
common causes to determine the most exposed areas of the project
and to help develop an effective risk response plan.
 Risk urgency assessment: In some cases, the risk of
urgency can be combined with the risk ranking, a method used to
evaluate the degree to which data about risks is useful for risk
management, generating a final sensitivity rating.
 Expert judgement: On many occasions it can be helpful
to take advice from experts, such as individuals with recent

experience on similar project cases, through interviews or risk
facilitation workshops.
Quantitative Risk Analysis Process aims to numerically analyze the
possibility of every risk and its effect on project objectives, as well as
the degree of overall project risk. This procedure uses several
techniques and methods such as data collection and representational
techniques to determine the probability of achieving project
objectives, to quantify the exposure to risks and develop a size and
cost assessment schedule.
 Interviewing stakeholders: To this end, one might carry out
interviews to gather information and form optimistic (low rating) and
pessimistic (high rating) risk scenarios.
 Sensitivity analysis: Helps to define which risks have the most
potential effect on the project. Generally, this analysis investigates the
extent to which the uncertainty of each of the project’s elements
influences the examination of the objective when other unclear
elements are held at their baseline values and can be represented via a
tornado diagram.
 Expected monetary values analysis (EMV): Is a statistical
method that measures the average outcome when the future includes
scenarios that may or may not occur (such as positive values-
opportunities, or negative values-risks). These are usually depicted by
a Decision Tree Analysis, which is a diagram describing a decision
under consideration and the implications of choosing from the
available alternatives. This diagram, includes probabilities of risks
and the subsequent cost or gain of each logical path.
 Modeling and simulation: Is a tool that uses a model that
converts the uncertainties into their potential impact on project
objectives, generalized to the level of the total project. To help with
this, one might use the Monte Carlo technique.
 Cost risk analysis: For cost estimation analysis traditional
project WBS can be used, otherwise, cost estimates can be used as
input values, chosen for each iteration incidentally, according to the
values probability distribution, in order to define the total cost.
 Schedule risk analysis: The Precedence Diagramming Method
(PDM) can be used for schedule risk analysis. It is a method of

constructing a project network diagram that represents the activities
and their connection with arrows to show dependencies. One can use
this activity-on-node diagram to check whether the project objective
will be completed by a certain date and within the cost estimation.
 Expert judgment: Obtaining advice from experts to identify
potential cost and schedule effects, evaluate possibilities, interpret
data and identify weaknesses and strengths can be of great value.
Risks constitute a common reality on all projects. One of the biggest
challenges a project manager has to face is to not become
overwhelmed by the number or magnitude of possible identified risks.
Instead, a good project manager should have the ability to focus on
the important elements that could threaten the project’s smooth
operation and subsequently develop a risk response plan. The risk
analysis process in project management is one of the most important
procedures in project management and it aims to minimize the
liabilities of the project and ensure its path to successful completion.
Social cost benefit analysis
A social cost benefit analysis is a systematic and cohesive method to
survey all the impacts caused by an (urban) development project or
other policy measure. It comprises not just the financial effects
(investment costs, direct benefits like profits, taxes and fees, et
cetera), but all the societal effects, like: pollution, environment,
safety, travel times, spatial quality, health, indirect (i.e. labour or real
estate) market impacts, legal aspects, et cetera. The main aim of a
social cost benefit analysis is to attach a price to as many effects as
possible in order to uniformly weigh the above-mentioned
heterogeneous effects. As a result, these prices reflect the value a
society attaches to the caused effects, enabling the decision maker to
form an opinion about the net social welfare effects of a project.
Project Financing: Financing of projects
If you are planning to start an industrial, infrastructure, or public
services project and need funds for the same, Project Financing might
be the answer that you are looking for. Project Financing is a long-
term, zero or limited recourse financing solution that is available to a
borrower against the rights, assets, and interests related to the
concerned project. The repayment of this loan can be done using the

cash flow generated once the project is complete instead of the
balance sheets of the sponsors. In case the borrower fails to comply
with the terms of the loan, the lender is entitled to take control of the
project. Additionally, financial companies can earn better margins if a
company avails this scheme while partially shifting the associated
project risks. Therefore, this type loan scheme is highly favoured by
sponsors, companies, and lenders alike.
In order to bridge the gap between sponsors and lenders, an
intermediary is formed namely Special Purpose Vehicle (SPV). The
main role of the SPV is to supervise the fund procurement and
management to ensure that the project assets do not succumb to the
aftereffects of project failure. Before a lender decides to finance a
project, it is also important that all the risks that might affect the
project are identified and allocated to avoid any future complication.
Concept of Venture Capital
Narrowly speaking, venture capital refers to the risk capital supplied
to growing companies and it takes the form of share capital in the
business firms. Both money provided as start-up capital and as
development capital for small but growing firms are included in this
definition.
In developing countries like India, venture capital concept has been
understood in this sense. In our country venture capital comprises
only seed capital, finance for high technology and funds to turn
research and development into commercial production.
In broader sense, venture capital refers to the commitment of capital
and knowledge for the formation and setting up of companies
particularly to those specialising in new ideas or new technologies.
Thus, it is not merely an injection of funds into a new firm but also a
simultaneous input of skills needed to set the firm up, design its
marketing strategy, organise and manage it.
In western countries like the USA and UK, venture capital perspective
scans a much wider horizon along the above sense. In these countries,
venture capital not only consists of supply of funds for financing
technology but also supply of capital and skills for fostering the
growth and development of enterprises.

Much of this capital is put behind established technology or is used to
help the evolution of new management teams. It is this broad role
which has enabled venture capital industry in the West to become a
vibrant force in the industrial development. It will, therefore, be more
meaningful to accept broader sense of venture capital.
Characteristics of Venture Capital:
Venture capital as a source of financing is distinct from other
sources of financing because of its unique characteristics, as set
out below:
1. Venture capital is essentially financing of new ventures through
equity participation. However, such investment may also take the
form of long-term loan, purchase of options or convertible securities.
The main objective underlying investment in equities is to earn capital
gains there on subsequently when the enterprise becomes profitable.
2. Venture capital makes long-term investment in highly potential
ventures of technical savvy entrepreneurs whose returns may be
available after a long period, say 5-10 years.
3. Venture capital does not confine to supply of equity capital but also
supply of skills for fostering the growth and development of
enterprises. Venture capitalists ensure active participation in the
management which is the entrepreneur’s business and provide their
marketing, technology, planning and management expertise to the
firm.
4. Venture capital financing involves high risk return spectrum. Some
of the ventures may yield very high returns to more than Compensates
for heavy losses on others which may also have earning prospects.
In nut shell, a venture capital institution is a financial intermediary
between investors looking for high potential returns and entrepreneurs
who need institutional capital as they are yet not ready/able to go to
the public.
Dimensions of Venture Capital:
Venture capital is associated with successive stages of the firm’s
development with distinctive types of financing, appropriate to each
stage of development. Thus, there are four stages of firm’s
development, viz., development of an idea, start up, fledgling and
establishment.

The first stage of development of a firm is development of an idea for
delineating precise specification for the new product or service and to
establish a business-plan. The entrepreneur needs seedling finance for
this purpose. Venture capitalist finds this stage as the most hazardous
and difficult in view of the fact that majority of the business projects
are abandoned at the end of the seedling phase.
Start-up stage is the second stage of the firm’s development. At this
stage, entrepreneur sets up the enterprise to carry into effect the
business plan to manufacture a product or to render a service. In this
process of development, venture capitalist supplies start-up finance.
In the third phase, the firm has made some headway, entered the stage
of manufacturing a product or service, but is facing enormous teething
problems. It may not be able to generate adequate internal funds. It
may also find its access to external sources of finance very difficult.
To get over the problem, the entrepreneur will need a large amount of
fledgling finance from the venture capitalist.
In the last stage of the firm’s development when it stabilizes itself and
may need, in some cases, establishment finance to explicit
opportunities of scale. This is the final injection of funds from venture
capitalists. It has been estimated that in the U.S.A., the entire cycle
takes a period of 5 to 10 years.
Functions of Venture Capital:
Venture capital is growingly becoming popular in different parts of
the world because of the crucial role it plays in fostering industrial
development by exploiting vast and untapped potentialities and
overcoming threats.
Venture capital plays this role with the help of the following
major functions:
Venture capital provides finance as well as skills to new enterprises
and new ventures of existing ones based on high technology
innovations. It provides seed capital to finance innovations even in the
pre-start stage.
In the development stage that follows the conceptual stage, venture
capitalist develops a business plan (in partnership with the
entrepreneur) which will detail the market opportunity, the product,
the development and financial needs.

In this crucial stage, the venture capitalist has to assess the intrinsic
merits of the technological innovation, ensure that the innovation is
directed at a clearly defined market opportunity and satisfies himself
that the management team at the helm of affairs is competent enough
to achieve the targets of the business plan.
Therefore, venture capitalist helps the firm to move to the exploitation
stage, i.e., launching of the innovation. While launching the
innovation the venture capitalist will seek to establish a time frame for
achieving the predetermined development marketing, sales and profit
targets.
In each investment, as the venture capitalist assumes absolute risk, his
role is not restricted to that of a mere supplier of funds but that of an
active partner with total investment in the assisted project. Thus, the
venture capitalist is expected to perform not only the role of a
financier but also a skilled faceted intermediary supplying a broad
spectrum of specialist services- technical, commercial, managerial,
financial and entrepreneurial.
Venture capitalist fills the gap in the owner’s funds in relation to the
quantum of equity required to support the successful launching of a
new business or the optimum scale of operations of an existing
business. It acts as a trigger in launching new business and as a
catalyst in stimulating existing firms to achieve optimum
performance.
Venture capitalists role extends even as far as to see that the firm has
proper and adequate commercial banking and receivable financing.
Venture capitalist assists the entrepreneurs in locating, interviewing
and employing outstanding corporate achievers to professionalize the
firm.
Difference between Venture Capital and Private Equity
Private Equity and Venture Capital are a type of financial assistance
provided to the companies at various stages. Due to the similarity in
their concept, they are taken as one and the same thing. However,
there is a considerable overlap amidst the two terms which is not
known to people. Private Equity involves larger investments in the
matured companies. Unlike, Venture Capital in which relatively small

sized investments is made, in the companies passing through initial
stages of their development.
Private Equity fund refers to an unregistered investment vehicle,
wherein the investors combine their money for investment purposes.
On the contrary, venture capital financing implies funding to those
ventures which possess high risk and promoted by new entrepreneurs,
who need money to give shape to their ideas.
BASIS FOR
PRIVATE EQUITY VENTURE CAPITAL
COMPARISON
Meaning Private Equity are the Venture Capital refers to

investments, that are made in financing of small business
those firms which are not by the investors, seeking
publicly listed on any stock high growth potential.
exchange.
Stage of Later stage Initial stage

Investment
Investments made Few companies Large number of companies

in
Companies Funds are provided to matured Investments are made in

companies having good track startup companies.
record.
Focus on Corporate Governance Management Capability
Industries All industries Industries that require heavy

initial investments like
energy conservation, high
technology, etc.
Risk Involved Less risky High risk
Fund Requirement For growth and expansion of For scaling up operations

business
Ownership of Generally, 100% Does not exceed 49%

investor
The term private equity refers to the capital investment made by the
investors or companies in the private companies that are not quoted
on the stock exchange. The funds may also be invested in a public
company to conduct buyout, through, which the public company will
be delisted. The investments are made at the maturity level of the
company, having a substantial operating history. The package may
include both equity and debt financing.
Private Equity firms buy an already existing company and restructure
it to develop further, expand and make it better than before.
Leveraged Buyout, Venture Capital, Mezzanine Capital and Growth
Buyout are the main strategies of Private Equity.
If you look at the private equity graph, you will observe that it has
become an important part of the financial services across the world in
last 20 years. It is one of the attractive funding options.
Definition of Venture Capital
Venture Capital is described as the capital contributed by the investors
or individuals to small enterprises or startup firms which are having a
fresh concept and promising prospects. The new private company is
not able to raise funds from the public, may go for venture capital.
Graphical Representation of Venture Capital

This kind of financing may involve a high degree of risk and whose
promoters are young & qualified entrepreneurs. They need capital
assistance for shaping their ideas. Venture Capital firms support the
growing companies in their early stages before they make a public
offer. The financier is known as Venture Capitalist, and the capital is
provided as equity capital.
Venture Capital funding is related to huge initial capital investment
business or sunrise sectors like information technology. The risk and
return factor in this type of funding are relatively higher.
The major differences between private equity and venture capital are
indicated below:
1. The investments made in the private companies by the investors
is known as Private Equity. Venture Capital, on the other hand, refers
to the capital contribution made by the investors with high risk and
return potential.
2. Private Equity, Investments is made at the later or expansion
stage, whereas in Venture Capital the investment is made in the early
stage i.e. seed stage or startup stage.
3. Private Equity firms make investments in few companies only
while Venture Capital firms, make their investments in a large
number of companies.
4. Private Equity funds are provided to matured companies that are
having a good record. Conversely, Venture Capital funds provided
small business but do not have the desired track record.
5. Private Equity investment can be made in any industry. As
opposed to Venture Capital, in which investment is made in high
growth potential industries like energy conservation, biomedical,
quality up-gradation, information technology and so on.
6. The risk profile in venture capital is comparatively higher than
private equity.
7. In private equity, the funds are utilized in the financial or
operational restructuring of the Vendee company. On the other hand,
venture capital funds are utilized in streamlining business operations
by way of developing and launching new products or services in the
market.
8. In general, private equity firms have 100% ownership in the
investee company, but venture capital firm’s ownership in the
investee company is not more than 49%
Project Implementation :- Last but not the least, every entrepreneur
should draw an implementation time table for his project. The
network having been prepared, the project authorities are now ready
to embark on the main task of implementation the project. To begin
with successful implementation will depend on how well the network
has been designed. However, during the course of implementation,
many factors arise which cannot be anticipated or adequately taken
note of in advance and built into the initial network. A number of
network techniques have been developed for project implementation.
Some of them are PERT, CPM, Graphical Evaluation and Review
Technique (GERT), Workshop Analysis Scheduling Programme
(WRSP) and Line of Balance (LOB).

Project Completion :- It is often debated as to the point at which the
project life cycle is completed. The cycle is completed only when the
development objectives are realized.
Project Report Preparation
Your company seeking financial assistance for implementation of its
business idea is required to prepare a Project Report covering certain
important aspects of the project as detailed below:
 Promoters background/experience
 Product with capacity to be built up and processes involved
 Project location
 Cost of the Project and Means of financing thereof
 Availability of utilities
 Technical arrangements
 Market Prospects and Selling arrangements
 Environmental aspects
 Profitability projections and Cash flows for the entire repayment
period of financial assistance
Spreadsheets formats attached with this document will help you
prepare a Detailed Project Report for your Bank. You may omit the
manufacturing related information in case you are applying for a non-
manufacturing project.
Since the appraisal of the Project involves evaluation of the Project in
the following areas, your company/you would be required to submit
certain documents/information in the matter.
Management Evaluation
 Memorandum and Articles of Association : Object, authorized
and paid-up share capital, promoter’s contribution, borrowing powers,
list of directors on the Board, terms of appointment of directors
 Your company as the Promoter : Corporate plan of the
Company, projects promoted/implemented/under implementation,
Bankers' report on dealings and repayment of past loan assistance,
details of group companies, operations, balance sheet and profit &
loss account of the promoter company
 New Promoters : Educational background, any industrial
experience, family background, sources of income, details of personal
properties, banker's reference, income tax/ wealth tax returns

 Management and Organization set up : Broad composition of
the Board, details of full time directors and their responsibilities,
details of Chief executive and functional executives including
qualification, experience, organization set-up for existing company
and during project implementation for new company.
Project Planning and Scheduling using Networking Techniques of
PERT / CPM
PERT and CPM are techniques of project management useful in the
basic managerial functions of planning, scheduling and control. PERT
stands for “Program Evaluation & Review Technique” and CPM are
the abbreviation for “Critical Path Method”. These days the projects
undertaken by business houses are very large and take a number of
years before commercial production can start.
The techniques of PERT and CPM help greatly in completing the
various jobs on schedule. They minimize production delays,
interruptions and conflicts. These techniques are very helpful in
coordinating various jobs of the total project and thereby expedite and
achieve completion of project on time.
PERT is a sophisticated tool used in planning, scheduling and
controlling large projects consisting of a number of activities
independent of one another and with uncertain completion times. It is
commonly used in research and development projects.
The following steps are required for using CPM and PERT for
planning and scheduling:
(i) Each project consists of several independent jobs or activities. All
these jobs or activities must be separately listed. It is important to
identify and distinguish the various activities required for the
completion of the project and list them separately.
(ii) Once the list of various activities is ready the order of precedence
for these jobs has to be determined. We must see which jobs have to
be completed before others can be started. Obviously, certain jobs will
have to be done first.
Many jobs may be done simultaneously and certain jobs will be
dependent upon the successful completion of the earlier jobs. All
these relationships between the various jobs have to be clearly laid
down.

(iii) The next step is to draw a picture or a graph which portrays each
of these jobs and shows the predecessor and successor relations
among them. It shows which job comes first and which next. It also
shows the time required for completion of various jobs. This is known
as the project graph or the arrow diagram.
The three steps given above can be understood with the help of an
example. Suppose, we want to construct a project graph of the simple
project of preparing a budget for a large manufacturing firm. The
managing director of this company wants his operating budget for the
next year prepared as soon as possible.
To accomplish this project, the company salesmen must provide sales
estimates in units for the period to the sales manager. The sales
manager would consolidate this data and give it to the production
manager.
He would also estimate market prices of the sales and give the total
value of sales schedules of the units to be produced and assign
machines for their manufacture. He would also plan the requirements
of labour and other inputs and give all these schedules together with
the number of units to be produced to the accounts manager who
would provide cost of production data to the budget officer.
Advantages of Pert:
The following advantages are derived from the pert:
1. It compels managers to plan their projects critically and analyse all
factors affecting the progress of the plan. The process of the network
analysis requires that the project planning be conducted on
considerable detail from the start to the finish.
2. It provides the management a tool for forecasting the impact of
schedule changes and be prepared to correct such situations. The
likely trouble spots are located early enough so as to apply some
preventive measures or corrective actions.
3. a lot of data can be presented in a highly ordered fashion. The task
relationships are graphically represented for easier evaluation and
individuals in different locations can easily determine their role in the
total task requirements.

4. The PERT time (Te) is based upon 3-way estimate and hence is the
most objective time in the light of uncertainties and results in greater
degree of accuracy in time forecasting.
5. It results in improved communication; the network provides a
common ground for various parties such as designers, contractors,
project managers etc. and they must all understand each other’s role
and contributions.
The network will highlight areas that require attention of higher
priority so that concentration can be applied to the key jobs without
ignoring the lower priority tasks. This gives the management an
opportunity to shift attention to any critical task so that the entire
project is completed in time.
Limitations of Pert:
Some of the limitations and problems that arise are:
1. Uncertainly about the estimate of time and resources. These must
be assumed and the results can only be as good as the assumptions.
2. The costs may be higher than the conventional methods of planning
and control. Because of the nature of networking and network
analysis, it needs a high degree of planning skill and greater amount
of details which would increase the cost in time and manpower
resources,
3. It is not suitable for relatively simple and repetitive processes such
as assembly line work which are fixed-sequence jobs.
Hence PERT is not very effective in manufacturing operations, since
it deals in the time domain only and does not deal with the quality
information which is necessary in manufacturing processes.
Methods of Project Appraisal
Some of the methods of project appraisal are as follows:
1. Economic Analysis:
Under economic analysis, the project aspects highlighted include
requirements for raw material, level of capacity utilization, anticipated
sales, anticipated expenses and the probable profits. It is said that a
business should have always a volume of profit clearly in view which
will govern other economic variables like sales, purchases, expenses
and alike.

It will have to be calculated how much sales would be necessary to
earn the targeted profit. Undoubtedly, demand for the product will be
estimated for anticipating sales volume. Therefore, demand for the
product needs to be carefully spelled out as it is, to a great extent,
deciding factor of feasibility of the project concern.
In addition to above, the location of the enterprise decided after
considering a gamut of points also needs to be mentioned in the
project. The Government policies in this regard should be taken into
consideration. The Government offers specific incentives and
concessions for setting up industries in notified backward areas.
Therefore, it has to be ascertained whether the proposed enterprise
comes under this category or not and whether the Government has
already decided any specific location for this kind of enterprise.
2. Financial Analysis:
Finance is one of the most important pre-requisites to establish an
enterprise. It is finance only that facilitates an entrepreneur to bring
together the labour of one, machine of another and raw material of yet
another to combine them to produce goods.
In order to adjudge the financial viability of the project, the following
aspects need to be carefully analysed:
1. Assessment of the financial requirements both – fixed capital and
working capital need to be properly made. You might be knowing that
fixed capital normally called ‘fixed assets’ are those tangible and
material facilities which purchased once are used again and again.
Land and buildings, plants and machinery, and equipment’s are the
familiar examples of fixed assets/fixed capital. The requirement for
fixed assets/capital will vary from enterprise to enterprise depending
upon the type of operation, scale of operation and time when the
investment is made. But, while assessing the fixed capital
requirements, all items relating to the asset like the cost of the asset,
architect and engineer’s fees, electrification and installation charges
(which normally come to 10 per cent of the value of machinery),
depreciation, pre-operation expenses of trial runs, etc., should be duly
taken into consideration. Similarly, if any expense is to be incurred in
remodeling, repair and additions of buildings should also be
highlighted in the project report.

2. In accounting, working capital means excess of current assets
over current liabilities. Generally, 2: 1 is considered as the optimum
current ratio. Current assets refer to those assets which can be
converted into cash within a period of one week. Current liabilities
refer to those obligations which can be payable within a period of one
week. In short, working capital is that amount of funds which is
needed in day today’s business operations. In other words, it is like
circulating money changing from cash to inventories and from
inventories to receivables and again converted into cash.
This circle goes on and on. Thus, working capital serves as a lubricant
for any enterprise, be it large or small. Therefore, the requirements of
working capital should be clearly provided for. Inadequacy of
working capital may not only adversely affect the operation of the
enterprise but also bring the enterprise to a grinding halt.
The activity level of an enterprise expressed as capacity utilization,
needs to be well spelt out in the business plan or project report.
However, the enterprise sometimes fails to achieve the targeted level
of capacity due to various business vicissitudes like unforeseen
shortage of raw material, unexpected disruption in power supply,
inability to penetrate the market mechanism, etc.
Then, a question arises to what extent and enterprise should continue
its production to meet all its obligations/liabilities. ‘Break-even
analysis’ (BEP) gives an answer to it. In brief, break-even analysis
indicates the level of production at which there is neither profit nor
loss in the enterprise. This level of production is, accordingly, called
‘break-even level’.
3. Market Analysis:
Before the production actually starts, the entrepreneur needs to
anticipate the possible market for the product. He/she has to anticipate
who will be the possible customers for his product and where and
when his product will be sold. There is a trite saying in this regard:
“The manufacturer of an iron nails must know who will buy his iron
nails.”
This is because production has no value for the producer unless it is
sold. It is said that if the proof of pudding lies in eating, the proof of
all production lies in marketing/ consumption. In fact, the potential of

the market constitutes the determinant of probable rewards from
entrepreneurial career.
Thus, knowing the anticipated market for the product to be produced
becomes an important element in every business plan. The various
methods used to anticipate the potential market, what is named in
‘Managerial Economics’ as ‘demand forecasting’, range from the
naive to sophisticated ones.
4. Technical Feasibility:
While making project appraisal, the technical feasibility of the project
also needs to be taken into consideration. In the simplest sense,
technical feasibility implies to mean the adequacy of the proposed
plant and equipment to produce the product within the prescribed
norms. As regards know-how, it denotes the availability or otherwise
of a fund of knowledge to run the proposed plants and machinery.
It should be ensured whether that know-how is available with the
entrepreneur or is to be procured from elsewhere. In the latter case,
arrangement made to procure it should be clearly checked up. If
project requires any collaboration, then, the terms and conditions of
the collaboration should also be spelt out comprehensively and
carefully.
In case of foreign technical collaboration, one needs to be aware of
the legal provisions in force from time to time specifying the list of
products for which only such collaboration is allowed under specific
terms and conditions. The entrepreneur, therefore, contemplating for
foreign collaboration should check these legal provisions with
reference to their projects.
While assessing the technical feasibility of the project, the following
inputs covered in the project should also be taken into consideration:
(i) Availability of land and site.
(ii) Availability of other inputs like water, power, transport,
communication facilities.
(iii) Availability of servicing facilities like machine shops, electric
repair shop, etc.
(iv) Coping-with anti-pollution law.
(v) Availability of work force as per required skill and arrangements
proposed for training-in-plant and outside.

(vi) Availability of required raw material as per quantity and quality.
5. Management Competence:
Management ability or competence plays an important role in making
an enterprise a success or otherwise. Strictly speaking, in the absence
of managerial competence, the projects which are otherwise feasible
may fail.
On the contrary, even a poor project may become a successful one
with good managerial ability. Hence, while doing project appraisal,
the managerial competence or talent of the promoter should be taken
into consideration.
Research studies report that most of the enterprises fall sick because
of lack of managerial competence or mismanagement. This is more so
in case of small-scale enterprises where the proprietor is all in all, i.e.,
owner as well as manager. Due to his one-man show, he may be jack
of all but master of none.
Feasibility Analysis
Feasibility Study – An Important aspect of Project Management
As the name implies, feasibility study is an analysis of the viability of
an idea. It ensures that a project is legally and technically feasible and
economically justifiable.
Moreover this study can be used in various ways with focus on the
proposed business. It tells us whether a project is worth doable or not?
Feasibility study is a must because:
Every Project is not doable.
Not every project should be done.
Not every project makes use of effective resources of company.
In its simplest terms, the two criteria to judge feasibility
are cost required and value to be attained. A well-designed study
should provide a historical background of the business or project, a
description of the product or service, accounting statements, details of
the operations and management, marketing research and policies,
financial data, legal requirements and tax obligations. Generally, such
studies precede technical development and project implementation.
A feasibility study evaluates the project's potential for success;
therefore, perceived objectivity is an important factor in the credibility
of the study for potential investors and lending institutions.

Five different areas of Project Feasibility:
 Technical Feasibility assessment is focused on the present
technical resource available in the organization. It studies if the
technical resources including the technical team are capable of
converting the ideas into working system. It also evaluates the
hardware and the software requirement of the proposed system.
 Economic Feasibility studies enable organizations to assess the
viability, cost and benefits of projects before financial resources are
allocated. They also provide independent project assessment and
enhance project credibility. It also helps to determine the positive
economic benefits to the organization that the proposed system will
provide. It includes quantification and identification of all the benefits
expected. This assessment typically involves a cost/ benefits analysis
of the project.
 Legally Feasibility of the project determines whether the
proposed system conflicts with legal requirements like any data
protection act or any social media law.
 Operational Feasibility, under which we conduct a study to
analyze and determine whether your business need can be fulfilled by
using a proposed solution. It also measures how well a proposed
system solves the problems, and takes advantage of the opportunities
identified during scope definition and how it satisfies the
requirements identified in the requirements analysis phase of system
development. To ensure success, desired operational outcomes must
be imparted during design and development. These include such
design-dependent parameters such as reliability, maintainability,
supportability, usability, disposability, sustainability, affordability and
others.
 Scheduling Feasibility is the most important in terms of project
success. A project will fail if not completed on time. In scheduling
feasibility we estimate how much time the system will take to
complete and with our technical skill we need to estimate the period
to complete the project using some methods.
Benefits

Conducting a feasibility study is always beneficial to the project and it
gives a clear picture of your idea. Below are the top benefits of this
study:
Gives focus to the project and alternative outline.
 Narrows the business alternative.
 Identifies the reason to do the project.
 Enhances the success rate by considering multiple factor.
 Helps in decision making of the project.
 Provides a detailed documented status to the business.
Apart from the above mentioned feasibility there are some other
constraints required to analyze like:
 Internal Project Constraints: Technical, Technology, Budget,
Resource etc.
 Internal Corporate Constraints: Financial, Marketing, Export
etc.
 External Constraints: Logistics, Environment, Laws and
regulation etc.
Environmental Scanning and SWOT Analysis
Environment literally means the surroundings external objects,

influences or overall circumstances under which someone or
something exists.
In Business the environment in which an organization exists could be
broadly divided into two parts:
a) The Internal environment (Related the factors such as its personnel,
physical facilities, organization and functional means, which are
generally controllable.
b) The External environment (Related the factors such as economic,
socio cultural, Government and legal, demographic, geo – physical –
by and large beyond the control
The External environment includes all the factors outside the
organization, which provide opportunities or pose threats to the
organization.
The Internal environment refers to all the factors within an
organization which imparts strengths or cause weaknesses of a
strategic nature. The environment in which an organization exists can,
therefore, be described in terms of the opportunities and threats
operating in the external environment apart from the strength and
weaknesses existing in the internal environment.
INTERNAL ENVIRONMENT:
There are a number of internal factors which influence the strategy
and other decisions. An outline of the important internal factors is
given below:
Value system: The value system of the founders and those at the helm
of affairs has important bearing on the choice of business, the mission
and objectives of the organization, business policies and practices. It
is a widely acknowledges fact that the extent to which the value
system is shared by all in the organization is an important factor
contributing to success.
Mission and Objectives: The business domain of the company,
priorities, direction of development, business philosophy, business
policy etc. is guided by the mission and objectives of the company.
Management Structure and Nature: the organizational structure,
the composition of the board of directors, extent of professionalization
of management etc. are important factors influencing business
decisions.
Internal Power Relationship: Factors like the amount of support the
top management enjoys from lower levels and workers, share holders
and board of directors have important influence on the decisions and
their implementation. The relationship between the members of the
Board of directors is also a critical factor.
Human Resources: The characteristics of the human resources like
skill, quality, morale, commitment, attitudes, etc. could contribute to
the strength or weakness of an organization. Sometimes, organizations
find it difficulties to carry out restructuring or modernization because
of resistance by employees whereas they are smoothly one in some
others.
Company Image and Brand Equity: The image of the company
matters while raising finance, forming joint ventures or other
alliances, soliciting marketing intermediaries, entering purchase or
sale contracts, launching new products etc. Brand equity is also
relevant in several of these cases.

EXTERNAL ENVIRONMENT:
The external environment consists of two types of environment, viz
micro environment and macro environment. Recently the
International environment comes under mega environment.
Micro Environment:
The Micro environment consists of the actors in the company’s
immediate environment, hat affect the performance of the company.
These include –
 Suppliers – those who supply the inputs like raw materials
 Marketing intermediaries – which are ‘firms that aid the
company in promoting, selling and distributing its goods to final
buyers’
 Competitors – not only other firms of similar products but also
all those who compete for the discretionary income of the consumers.
 Customers – Business is a create of customer; therefore
monitoring the customer sensitivity is a prerequisite for the business
success.
 Publics – is any group that has an actual or potential interest in
or impact on an organization’s ability to achieve its interests. Media
publics, citizen’s action publics and local publics are some examples.
Macro Environment: The Macro environment consists of the larger

societal forces that affect all the actors in the company’s micro
environment – namely:
• Demographic – population growth rate, age composition, sex
composition, education level, caste and creed, religion etc. All factors
which relevant to business.
• Economic- economic condition, economic policies and the
economic system are the important external factors that constitute the
economic environment of a business
• Natural – geographical, and ecological factors, such as natural
resources endowments, weather and climatic conditions, topographic
factors, location aspects in the global context, ort facilities, etc. , are
all relevant to business
• Technological – the fast changing technologies also create problems
for enterprises as they render plants and products obsolete quickly.
Product – market – matrix generally has a much shorter life today
than in the past. It is particularly so in the international marketing
context.
• Political – Political and Government environment has close
relationship with the economic system and economic policy. For
example, the communist countries had a centrally planned economic
system. In most countries, apart from those laws that control
investment and related matters, there are a number of laws which
regulate the conduct of business. These laws cover such matters as
standards of product, packaging, promotions etc.
• Socio – Cultural: socio – cultural fabric is an important
environment factor that should be analyzed while formulating the
business strategies. The cost of ignoring the customs, traditions,
taboos, tastes and preferences etc. of a people could be very high. The
buying and consumption habits of the people, their languages, beliefs,
and values, customs and traditions, tastes and performances,
education are all factors that affect business.
The micro environment is also known as task environment and
operating environment.
Mega Environment:
Mega environment mainly consist of International Environment
which is very important from the point of certain categories of
business.
A. Import and export dependency
B. World trade linkage
Factors to be consider for environmental scanning:

1. Events are important and specific occurrences taking place in
different environmental sectors.
2. Trends are the general tendencies or the courses of action along
which events take place.
3. Issues are the current concerns that arise in response to events and
treats.
4. Expectations are the demands made by interested groups in the
light of their concern for issues.

Methods and Techniques used for Environmental Scanning (ES):
There are wide range of methods and techniques available for ES.
Strategists may choose one which suit their needs in terms of the –
• Quantity
• Quality
• Availability
• Time lines
• Relevance
• Cost of environmental information

MBA 2018
SUB CODE : MBAGE 201-18
SUBJECT NAME:
COMPUTER APPLICATIONS FOR BUSINESS

UNIT - 1
Understanding the Foundations of Business Communication: Business Communication concept,
Communication Models, Communication Process, Characteristics of effective business
communication, Barriers in communication environment, Communication and Ethics, Cross
Cultural Communication;
Guidelines for successful collaborative writing, Social networking technologies in business
communication, Importance of listening, business etiquette & nonverbal Communication
UNIT - II
The Three-Step Writing Process: Importance of analyzing the situation before writing a message,
Information-gathering options, Information organization, Writing Business Communication:
Adapting to your audience, Crafting brief messages, Crafting messages for electronic media,
Writing routine and positive messages, Writing negative messages; Planning, Writing, and
Completing Reports and Proposal and Emails.
UNIT – III
Designing and Delivering Oral and Online Presentations: Developing oral and online
presentations, Enhancing presentations with slides and other visual aids, Just-A-Minute
Presentation, Individual/Group Presentations, Feedback and overcoming Glossophobia, Group
discussion.
UNIT - IV
Writing Employment Messages and Interviewing for Jobs: Employment strategy, Planning,
writing and completing your resume, Applying and Interviewing for Employment:
Understanding, preparing and follow-up, Role Play and Simulation games – Employer -
employee and Interviewer – interviewee relationship.


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MANUAL

1 MBA, 2018. SEMESTER 2

SUBJECT CODE SUBJECT PAGE

MBA 203-18 MARKETING MANAGEMENT

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SUB CODE : MBA 201- 18

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