FM 1 Material

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s in order to generate t he profits. Thus, production, marketing and finance a re theoperational areas in case of any manufacturing activity out a f which th e finance

le most crucial area. I t is so because the functions of production and marketing areo related to finance ultimately. If the decisions rela ting of funds or money fail, it may

n the de ath of the organization. The decisions regarding mo ne yl f~ ~n dsay malrcestroy the organization. The inte rest s of so many persons may be directly affectedto the success or failure of a n organization.

g. : Owners (shareholders)CreditorsSuppliers,Lenders of moneylfundsEmployeesPublic a t large . .

As such an organization ha s to be very careful while dealing with funds or money.Approaches t~ the term Finance :The concept of finance ha s changed markedly with the change -in times and'circumstances. The various views on the finance can be categorized as sta ted below:

. I .


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This approach towards finance was criticized on various grounds .(a) It is too narrow and restrictive in nature. Procurement of the funds is only on

of the functions of finance and other functions are ignored by this approach.(b) It considers the financia l problems only of corporate ente rpri ses. In t ha t sense,

concerns, partners hip firms etc.(c ) It considers only th e basic and non-recurring problems relat ing to the business.

a business.


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INTRODUCTION

( ;I ) Financing Decisions(11) Investmeilt Decisions( c ) Dividend Policy Decisions

Pinancing Decisions :'~'Ircsedecisions are basically concerned with the process of acquiring the funds. Any'J ~ \ ~ ~ i n e s sctivity is basically, concerned with raising of the funds, whenever required,gp~ploying hese funds for manufacturing and selling the products in the mark et andqfir'ning the profits out of the same. Thusobt ain ing the funds for their deployment in$!I(? business is the star ting point of any business activity. Fur ther , the funds requiredby tihe business may be raised either by own sources (Equity Capital) or by outsidegburces (Debt Capital) The financing decisions are basically concerned with the

(1)What should be the amount of the funds that should be raised?

[nvestment Decisions :T11e second area with which the finance deals is the utilisation of the funds raised and

( l i ) Curr en t Asse ts :These are those properties which a re created during the courseof business and are capable of getting converted into cash usually within a year.

(i) api t a l Budget ing :

made under situation of risk and uncertainty?. .(ii) Working Capi tal Management :The investment decision in this areas are basically concerned with deciding the .optimum extent to which the funds should be invested in current a sset s. If the company


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INTRODUCTION

Both the proposals A a.nd B involve same amount of profits and hence ideallyshould be treated on par. B ut it will not be proper a s proposal A involves higheramount of re turn s in t he earli er years, while proposal B involves thereturns inthe later years. 1 t makes proposal. A more profitable ultimately as the returnsreceived earlie r are more valuable than the r et urns received lat er . The objectivesand the returns received later.

t4 ) Proflt maximization as th e objective doesn't take into con sideration th e social

Ali such, profit maximization can't be a prime objective of the finance function. Theol3,jective ha s to be one having more broad a base, which is more precise , which

I..)ue to the limitations attached with the profit maximization as an objective of theI'inance function, it is no more accepted a s he basic objective. As agains t it, it is nowiiccepted th a t the objedtive of the business should be to i~~ax ir rl izets wealth and value .

tnaximization due to following reaso ns.

' earlier are more valuable t ha n those generated l a t e r . Th at is why whilecomputing value of total benefits, th e cash flows are discounted a t a certaindiscounting rate. At the same time, it recognises the concept of risk also, by


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BASIC FINANCIAL MANAGEMENT f -4 smaking necessary adjustments in discounting rate. As such, cash flows of ;ifproject involving higher risk are discounted a t a highe r disco unting rate and8

, vice versa.1 Thus, the discountin g rate used to discount fut ure cash flows reflects the concepts ofI both time and risk.

Due to the above rea son s, th e wealth maximization is considered to be superio r to profilmaximization a s a n objective or goal of finan ce function. However, i t should be notedth at w ealth maximization goal is only an extens ion of profit maximization goal. If thotime period is too shor t and risk elements i s minimum, both wea lth maximization andprofit maximization will mean the same thing.Organization of Finance Function : 8At the outset, it mus t be cleared th at the re is no st and ard pa tt er n for the organizationof finance function. It varies from th e enterprise to ente rpris e an d its characteristics interms of nature, size, convention etc. In smaller concerns, where the operations arcrelatively less complicated and simple, the re may not be sep era te executive to look afterI finance function. In fact, the proprietor or partners only will be looking after all thefunctional areas like production, marketing, finance etc.In bigger concerns, the execution of finance function becomes a specialised task andmay be handled by an executive who may be in the form the Treasurer, FinanceController, Finance Manager, Vice-President (Finance) and so on. H e is generally giventhe charge of credit an d collection accounting, inves tment a nd au di t departments. Heis responsible for preparing annual financial reports. He reports directly to thePresident and Board of Directors.Secondly, it should be noted that generally the organisation of finance is centralized I 1one, unlike other businesss functions. Board of Directors takes the main 'financialdecisions. Board of Direc tors may delegate th e powers to the executive committee.comprising of managing director, other one or two directors and finance officer of thecompany. Thi s executive committee t akes all th e financial decisions . Routine financialmatters mav delegated to lower level officers. The reasons for finance beine hiehlv "centralized function arc very obvious.

(1)Finan cial decisions ar e the most crucial ones on which survival or failure on the 'organization depends.

( 2 ) Finan cial decisions affects the solvency position of the organ ization an d a wrongdecision in th is a rea may land t he organization i n to crisis. $ 1( 3 ) The organiza tion may ga in economies of centralization in the form of reducedcost of rai sin g the f und s, acquisition of fixed asse ts a t th e competitiveprices etc.

Though there is not standard pattern for organization of finance function, in generalterms, the organization of finance function takes the following form.


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Executive Committee

Vice President Vice Pres ident(Marketing)

Finance Controller(1)Accounting and Costing

Duties and Responsibilities of F inance ~kecu t iveOn the basis of thescope of the finance, which has already been discussed, the various,

(1) Recurring Duties.(2) Non-recurring Duties.

executive should as se ss this need of funds properly.


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BAS!@ FINANCIALMAWAGEMEN

in the form of sha res or debentures, h e has to arran ge for the un.derwritinglist,ing of th e same. If th e co!n.pany decides to go in for borrowed. capi ta l, he hasnegotiate with the lenders of the funds.

( c ) A l I o c a ~ i o n f Funds :The financial executive has to ens ure prope r allocationfunds. l ie can allocate the funds basically for two purposes.

company should invest the funds. He has to ensure that the fixed assacquired or to be acquired satisfy the present as well as future needs of tcompany. He has to ensure th at the funds i~ive sted11 th e fixed ass et s justify tinvestments in term s of the expected cash flows generated by them i n future.there are more than one proposals for lnakirig in fixed assets, the finanFo r this purpose, he may be required to tak e the help of various techniques

in order to facilitate the replacement of fixed asse ts afte r thei r economic life i~over, proper depreciation policies are formulated. The wrong policies i n the areaof providing for the depreciation may result into over-capitalisation or under-capitalisation.

(ii) Working Capital Management : The finance executive has to ensure t h esufficient funds are made vaailable for investing in current assets as it is thelifeblood of the business activity. Non-availability of funds to invest in curreni,asse ts i n the form of' say cash, receivables, inventory etc. may ha lt th e businessoperations. At th e sa me time, he h as to ensure th at th ere i s no blocking of fundsin th e cur rent as sets, a s it m ay prove to be costly in term s of cost of these fundsand also in terms of opportunity cost of their use. 'Thus, the finance manager has. to ensu re tha t investme'nts in th e curre nt assets is minimum witho ut affectingthe operations of the company.

(d) A l l o c a t i o n of Income :Allocation of the income of the company is the exclusiveresponsibility of the finance executive. For th is purpose, basica lly th e income maybe distributed among the share hlder s by way of dividend or i t may be retained intaken in the light of financial position, present and future cash requirements,preferences of the shareholders etc.

(e) Con t r o l s f Funds : he finance executive is responsible to cont,rol the u se of fundscommitted in the business so as to en sure th at cash is flowing as per the plan andif th er e is any deviation between est imate s and plan s, proper corrective action lnaybe tak en in the light of financial position of the company. For thi s purpose, he lnaybe required to supervise the cash receipts and disbursements, ensur e the sa fety ofcash receipts and disbursements, ensure the safety of cash balances, expediatereceipts and delay the payments h her ever possible etc.


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llJ1110DUCTION 191

I 1 ' ) ICvaluation of Performance -: The financial executive may be required toc:vnluate and inte rpret th e financial statements, financial position and operations '.ol ' Ihe company. For this purpose, he may be required to ensure that proper booksrind records are maintained in proper way so tha t whatever da ta is required for this

Ilow statm ents etc.i g ) Corporate Taxat ion :As th e company is a separate legal entit y, it is subjected to

l,hevarious direct and indi rect taxes like income tax, wealth'tax , excise and custolnsduty, sales tax etc. The finance executive may be expected to deal with t he varioust,ax planning and tax saving devices in order to minimize the tax liability.

( 1 1 ) Other Dut ies : n add ition to all t he above duties, the financial executive may berequired to prepare annual accounts, prepare and present financial reports to topmanagement, carrying out internal audit, get done statutory and tax audit,safeguarding securities and assets of company by properly insuring them etc;

c!~ieis,valuation of the enterprise at the time of acquisition and merger thereof etc.Plelds of Finance :'llhere can be various fields in which the finance function.may operate. In each field,

01' finance can be s ta ted as. below.term. It covers all the activities carried on with the intention of earning profits.Thus, business finance covers the study of finance function in t he ar ea of businesswhich includes both tra de as well as industry.

(2)Corporat ion F inanc e : Corporation Finance is a p a r t of business finance anddeals with the financial practices, policies and problems of corporate enterprises orcompanies to describe in simple words. The corporation finance studies the financialoperations carried on by a coporate enterpri se from the stage of it s inception to thestage of its growth and expansion.between invididuals and,organizations beyond national boundaries and developingthe methods to handle these funds more effectively. This study may become crucialas i t involves exchange of currencies , and also as the governments of either of the

becomes crucial as the-Governments deal with huge sums of money ivhich can be


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BASIC FINANCIAL MANAGEMENT I

raised through the sources like taxes or other methods and are required to bcutillised within the statuto ry and other limitations. Furt her , the Governments don'toperate with t he objectives similar to th at of th e private organization, i.c ., earningthe profits is not the intention with which the Governments operate, but theyoperate with the intention of accomplishing social or economic objectives.

(5) Private Finance : It deals with the financial matters of non-governenlorganizations.

Finance Function in relation with other functions :Other th an finance, every business generally operates in these main functional are;lviz. Production, Mark etin g and Personnel. A11 these functions a re closely related tofinance function due to th e simplest reason t ha t for executing these functions, fund^are required which is the area covered by finance function.For example to produce good quality of finished goods, the business needs gootlinfrastuctural facilities like building, machineries etc. A regular flow of productiollrequires facilities like quality raw material, work in progress, consuinable storefl,quality control equipmerits, good maintenance facilities etc. All these activities need t 1 ~ 1investment to be made either in terms of fixed capital and/or working capital which i~the area of finance function. To market the finished goods and guarantee regular flowof goods in th e m arke t, i t may be rqu ired to have good dis tribution systems which maycall for investment in ter ms of fixed assets or labour force. A11 these activities need th(rinves tmen ts to be made eith er in terins of fixed capital and/or working capital which itithe area of finance function. The Personnel function deals with the availability ol 'proper kinds of labourers at proper time, training them properly and fixing their jol)responsibilities. All these activities needs funds , e.g., to pay sal ari es, wages a nd othol$facilities to workers, funds ar e needed. To provide tr ain ing facilities to workers, it maybe necessary to invest in some fixed assets like building or equipments etc.To conclude, it may be st at ed t ha t all th e functions or activitie s of th e business an1ultimately rela ted to finance. The success of the business depen ds on how best all thewfunctions can be coordinated.

i 1. Describe the scope and importance of the finance function in the management oi! corporation.2 . Explain the meaning, nature and scope of Finance Function.3 . Explain the organizational framework of finance function. State the relation ofinance to other functions of a business enterprise.4. What are the duties discharged by the financial executive in a large businorganization.5. (a ) Explain the trad itio nal and modern concept of finance function.


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The finance function of the organiza tion if greatly affectcd by the forms of orga i~ization.In practical circum stanc es, we come across basically t hre e forms of businessorganisations.

(a)P r o p r i e t a r y F i r m s(b)P a r t n e r s h i p F i r m s(c) J o i n t S t o c k C o mp a n ie s

Advantages :(a ) P roprie tory Firm s is the easiest an d most economical form of business organization

to form and operate. No t many of the government regulations a re applicable to theProprietory Firms .(b) This form of organization is a very silit,able where business operations are small in


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I SIRMS OF BUSINESS ORGANIZATION 1113s

I 1,) A s only one person is th e owner and the manager, the capacity of th e business toraise the funds and to cope up with the comnplex busine. . . . mparatively-- --l in2ited. ..-I ( ! ) l'roprietory firm is always a. unlimited liability organization. In the sense , if theassets of the firm are insufficie~to meet i ts liabilities, ~ e r s o n a l rowcirtv of the

E:t proprietor is always at stake.g> ( ( 1 ) The income of the proprietory firm is clubbed with the individual income of thea proprietor. As such, effective rate of income tax which the proprietor may beI required to pay is likely to be higher.

( ( 1 ) It is not possible to transfe r th e ownership of the bus iness to somebody else withoutaffecting the basic constitution of the business.I'lrrtnerskip firms ------------1 11 this case, more than two persons but less than twenty persons come together andI'orm a partnership firm. Each of these partners is the owner of the business in thej)~$oportion ecided among themselves. Partnership is a contract among the par tnerstrlrd the relationship among the partners is governed on the basis of terms andclonditions laid down in a official and wr itten document called as "Par tnersh ip Deed" or"l'tlrtnership Agreement".

(!H )i Advantages(11) This form of organization is also reasonably easy and economical to form and

operate.i h ) As resources of more than one person a re pooled together, capacity of the businessto handle more complex business operations or operations requiring more amount

of funds is better as compared to the proprietory firms.i c ) The tax structure applicable to the partnership firms is fairly reasonable. Atpresent, profit of the pa rtnership firm is taxed a t a f la t ra te of 30%. While

I I I calculat ing the profit of the par tnership firm, following amounts can be claimed bythe Grm as the allowable expenditure.(i ) The Firm' can pay interes t on capital to the par tners on the am ount of capital

111 introducted by them in the business but the rat e of inter est can not exceed 12%I ( ' per annum. This interest on capital can be paid by the firm to all the partners.E (ii) The firm can rem unerate the part ner s in the form of sa lary , bonus, commission

etc. provided that the part ners are ""working partners". A working pa rtner i s apartner who is capable of part icipa ting in the day-to-day affairs of the firm byvir tue of experience or qualifications. However, the firm can not remunerate thepartners to any extent it wants. The maximum amount of remuneration whichthe firm can pay to all the working partners taken together is prescribed in, Income Tax Act, 1961. Section 44AA of the said act provides the maximumamount of remuneration w h i c h ' m m can pay to its working ~ a x ~decided on the basis of the "bool; pr o fi ts bh? cr 6e an s t


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BASIC FINANCIAL MANAGEMENT

per its profitability statelllent after calculating the interest on capital paid to thepartner s. After deciding the amount of book profit, the rem uneration is decidedas below:If the firm is carrying on a profession :(a ) On the fir st Rs.1,00,000 of the book profit or in case of a loss - Rs. 50,000 or

90% of the bboi profit whichever is more.j(b) In the next Rs. 1,00,000 of the book profit, a t the ra te of 60%.

(c ) On the balance amount of book profit, at the rate of 40%.In case of any other firm :(a) On the f irs t Rs. 75,000 of the book profit or in case of a loss - Rs. 50,000 or90% of the book profit whichever is, more.(b) On the next Rs. 1,00,000 of the book profit, a t the rat e of 60%.( c ) ' On the balance amount of book profit, at the rate of 40%.

However, it should be remembered th a t the amount of inte res t on capitalpaid by the firm and the remuneration paid to the pa rtners is taxable in thehands of individual partners.After charg ing the above amaunts, the balance amount of profits aretransferred to the capital account of the partners which is referred to as"share of profit" and thi s share of profit is not taxable in the hands ofindividual part ner s.(d) Not many of the government regulations are applicable to the partnership

Disadvantages :( a ) This form of organisation also-does not-l?av~any,lega~stat.~1s.hepartn ership firmsexist due to the exSf ~iZe ~-o fhe partners. If the par tne rs cease to be in existence,

. t he firm ceases to be in existence. The retirement or death of a partner leads to the


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F@[PMSOF BUSINESS ORGANIZATION[yiy~~nixations split into smaller units, each of such units being called as a


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~ 1 6 ~ BASK FBIdANCIALMANAGEMENT

the comlnon seal and witi~essed v atlcast two dire ctois is bindil-ie on thr comnanvI Advantages :

possible to raise large arnounk of funds.( 2 ) As th e company has a sep ara te legal enlity, ap ar t G*om ts owners, viz., shareholders,

the personal property of the shareholders is generally not in dangom-.( 3 ) Transferability of shares is a facility available to the sllareholders. i f the shareholders

want to release their investment in share s, they call transfer th eir sha res to anyother person. However, it should be re~n ?inbe red ha t in case of pri vate limitedcompanies, the share s ar e not freely transferable.

Disadvantages :(1)The company form of organizatioils ar c subjected to elabo rate legal a i d procedural

formalities to be completed not only for ,,he purpose of forrnatioil bu t also for thcregular operation. The basic applicable law in this connection is in the form of '

(2) Till the recent past, double taxa1,ion used to be a typical charac terist ic feature of acompany form of organization. 'The company wzs supposed to pay the tax on t.hc

not be treated as a taxable income. However, the company is requir'ed to payaddit ional tax on the a mou nt of dividend payable by it. This t ax is referred to as"Tax on dis tribu table profits" or in more simple language "dividend tax". At, present,th e ra te of dividend tax is 15% of the a ~n o u n t f dividend payable a nd t his is overand above the normal corporate tax payable by the company. This imposesadditional tax burden on the company.

Types of Companies :-In practical circumstances, we find mainly two types of' limited liability companies.(a ) Private Limited Company

(b) Public Limited Company.Private Limited CompanyIn non-technical language, operations of a private limited company, affect the fat e osmaller number of people. As such, Conipanies Act, 1956 is very liberal towards thc~ r i v a t eimited com ~an ies . rivate Limited C om ~ an vs entitled to manv ~rivilerresl


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PI1IjMS OF BUSINE SS ORGAMlZPirleBN 81171ii~ I I\' r r r ~ Minimum number of shareholders is 2 and the maximum number is 50. --. Ak .-r l r r A Private Limited Company can not approach public in general for subscribing to

l, l lc sharesldebentures of the company. The funds requried by the compXnT are-)-oquired o be collected through the private circulation only.--

atzl In case of a Private Limited Company, right of the shareholders to transfer the~ l ~ a r e ss restricted. These restrictions ar e usually in two forms ---- __( i that the shares to be transferred should be offered to the existing members on

priority basis and if the existing members do not want to take up those share,they can be transferred to anybody else.(ii)ha t the directors will have the power to refuse to registe r the t ran sfer of sharesprovided that such power should be exercised by the directors in good faith andin the int eres t of th e company.

I d l A Private Limited Company can not invite or accept deposits from persons otherthan its members, directors or their relatives. /I l l \ -----\ie ) A Private Limited Company needs to have a minimum paid up share capital of Rs.1 1 1 1 Lakhs or any higher amount as may be prescribed.( $ 0 l*\rl>licLimited Company

In lion-technical language, a public limited compnay affects the fate of larger numberI I I ~l\rblicimited company is characterized by the following~~u-xes.

I (1:) The shareholders of a public limited company can freely trans fer t he ir shares to anyH I & other person. As such , share s of only a public limited company can be listed on the

r1, Explain the following fornls of organization in which business can be carried out -

( a ) Proprietary Firms (b ) Part ners hip Firms (c) Company2, Write short notes on -

(a) Taxation of Par tner ship Firms(b) Private Limited Company(c ) Public Limited Company

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