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the ratios can be used for predicting corporate insolvency Student may refer to FSP(N) Advanced accounts-4 wherein it has been discussed how the ratios can be used for predicting corporate insolvency and corporate bankruptcy. As far as the case of industrial sickness in India is concerned, the Tiwari Committee had identified certain symptoms which would be quite helpful in the detection of sickness are continuous irregularity in cash credit accounts, low capacity utilisation, profit fluctuations, downward trends in sales and stagnation or fall in profits followed by contraction in the share of the market, High rate of rejection of goods manufactured, reduction in credit summations, failure to pay statutory liabilities, larger and longer outstanding in the bill accounts, longer period of credit allowed on sale documents negotiated through the bank and frequent returns by customers of the same, constant utilisation of cash credit facilities to the maximum and failure to pay timely instalment of principal and interest on term loans and instalment credits, non-submission of periodical financial data/stock statements, etc. in time, financing capital expenditure out of funds provided for working capital purposes, rapid turnover of key personnel, existence of a large number of law suits against the company, rapid expansion and too much diversification within a short time, sudden/frequent changes in management- whether professional or otherwise and/or dominated by one man/few individuals, diversion of funds for purposes other than running the unit, any major change in the shareholdings. Use of ratios for predicting sickness : A good deal of research has been done is using ratios for predicting sickness of an enterprise. Two types of studies viz., univariate and multivariate help in production. The former uses individual ratios whereas the latter encompasses several ratios. Studies have been conducted in India and abroad and the following ratios are used in prediction by the formulation of a model : Cash flow to total debt, net income to total assets, total debt to total assets, working capital to total assets and current assets to current liabilities. These ratios were selected by Beaver. Altman developed an empirical model using multiple discriminate analysis. His model was: Z=1.2 x1+1.4 x2+3.3 x3+.6 x4+1.0 x5 Z= Overall index of the multiple discriminant function x1= Working Capital/Total Assets x2= Retained Earnings/Total Assets x3=EBIT/Total Assets x4= Market value of Equity/ Book value of Total Liabilities x5= Sales/Total Assets more than 2.99 there is no danger of bankruptcy, Z score below 1.81 indicates imminent insolvency and Z score between 1.81 and 2.99 shows the grey area. Similar models have been developed by others also. Debt Service Coverage Ratio (DSCR): This ratio indicates the ability of a project to service the debt i.e. payment of interest and repayment of principal within the stipulated time. In order to assess the ability of the project to service the debt it is necessary in the first place to find out the gross cash accruals and then correlate the same with the liability in respect of payment of interest and repayment of the instalments of the principal amount. The Financial institutions are very keen to ensure that the project has sufficient strength to service the debt. The institutions would normally be satisfied with an average DSCR in the range of 1.6 to 2.0 times.

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Investment & Portfolio Management 1. i. Basis Principles of Portfolio management There are two basic principles of portfolio management, viz. Effective investment panning for the investment in securities by considering the following factors : a. fiscal, financing and monetary policies of the government and the Reserve Bank of India. b. industrial and economic environment and its impact on industry prospects in terms of prospective technological changes, competition in the market, capacity utilisation by the industry and demand prospects, etc. ii. Constant review of investment : Portfolio managers are required to review their investment in securities and continue selling and purchasing their investments in a more profitable avenues. For this purpose, the following analysis is required : a. Assessment of quality of management of the company. b. Financial and trend analysis of Balance Sheet and Profit and Loss Account items in order to direct the flow of investments to profitable avenues. c. Analysis of securities market.

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Objectives of portfolio management : Portfolio management refers to the selection of securities and their continuous shifting in the portfolio for optimising the return for investor. The following are the objectives of portfolio management : i. Security / safety of principal : Security not only involves keeping the principal sum intact but also keeping intact its purchasing power. ii. Stability of income : So as to facilitate planning more accurately and systematically the reinvestment or consumption of income. iii. Capital growth : Which can be attained by reinvesting in growth securities or through purchase of growth securities. iv. Marketability : The ease with which security can be brought or sold. This is essential to provide flexibility to investment portfolio. v. Liquidity : It is desirable for an investor to take advantage of attraction opportunities in the market. vi. Diversification ; The basic objective of building a portfolio is to reduce the risk of loss of capital / income by investing in various types of securities and over a wide range of industries. vii. Favourable tax status : The effective yield an investor gets from his investment depends on tax to which it is subjected. By minimising tax burden, yield can be improved effectively.

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The issue of bonds may carry two options: Call option: under this the issuer can call the bonds for redemption before the date of maturity. Where the issuers share price has appreciated substantially, i.e., far in excess of the redemption value of bonds, the issuer company can exercise the option. This call option forces the investors to convert the bonds into equity. Usually, such a case arises when the share prices reach a stage near 130% to 150% of the conversion price. Put option enables the buyer of the bond a right to sell his bonds to the issue company at a pre-determined price and date. The payment of interest and the redemption of the bonds will be made by the issuer-company in US dollars. Global depository Receipts (GDRs) :It is a negotiable certificate denominated in US dollars which represents a Non-US companys publically traded local currency equity shares. GDRs are created when the local currency shares of an Indian company are delivered to Depositorys local custodian Bank against which the Depository bank issues depository receipts in US dollars. The GDRs may be traded freely in the overseas market like any other dollar- expressed security either on a foreign stock exchange or in the over-the -counter market or among qualified institutional buyers. By issue of GDRs Indians companies are able to tap global equity market to raise foreign currency funds by way of equity. It has distinct advantage over debt as there is no repayment of the principle and service costs are lower. (Students may refer to FSP (N) MAFA-10 study paper for detailed discussion) Dow Jones theory : Dow Jones theory deals with the behaviour of share prices in the market. According to Dow Jones theory, the movements in the share prices on the share market can be classified into the following three major categories: (a) The primary movements. (b) The secondary movements. (c) The daily fluctuations. The primary movements reflect the trend of the share market and may continue from one of three years or even more. If one observes the long range behaviour of share prices in the market, it may be seen that for sometime a definite consistent phase, i.e., rise or fall in prices is observed. The former is known as bull phase and latter as bear phase. The secondary movements refer to the intervening movements in prices which last for a short period say three weeks to several months but , running counter to the primary trend. The secondary movements are supposed generally to retrace from one-third to two-thirds of the previous advance in a bull market or previous fall in the bear market. The daily movements refer to every days irregular fluctuations in share price in either direction. These fluctuations are the result of the activities of speculators. An investor really is not interested in such fluctuations and, therefore, he should keep himself away from them. The understanding of Dow Jones theory proves useful for an investor. The theory may help him in choosing the time for investment in shares. According to this theory, investment should be mad in shares when their prices have reached the lowest level and sell them at a time when they reached the highest peak. In practice, it may be difficult to identify these points or trends. The Dow Jones theory in its pure form retains few followers today because it has generally failed to be leading indicator of future stock prices and it has not enabled the investors to achieve superior investment performance.

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The theory of Dow Jones has been improved upon by some of his successors. The development of Random Walk Theory is one such improvement. 6. Euro Convertible Bonds: They are bonds issued by Indian companies in foreign market with the option to convert them into pre-determined number of equity shares of the company. Usually price of equity shares at the time of conversion will fetch premium. The bonds carry fixed rate of interest. Arbitrage: The term arbitrage is used in many areas of finance. it refers to the process of buying and selling securities. The sale/purchase takes place within an unstable capital market. The prices are affected by supply and demand and arbitrage helps in adjusting the market to an equilibrium. The process of buying in one market and selling the same in another market is known as arbitrage. Modigliani and Miller (M &M) have suggested that if two companies have the same level of business, as such, they must, all things being equal have the same weighted average cost of capital, and if they also have the same level of earnings, the companies will have the same total market value. If this situation does not prevail, as is proposed by the traditional theory, M & M argue that shareholders will undertake arbitrage operations which will result in share price returning to equilibrium. The transactions involved in arbitrage process are that shareholders in a company with the lower weighted average cost of capital sell their shares and purchase shares in the company with the higher weighted average cost of capital borrowing and lending to maintain the same level of risk-return before and after. The simple, but powerful, notion in arbitrage is that security prices adjust as market participants search for arbitrage profits. When such opportunities have been exhausted, security prices are said to be in equilibrium. In this context a definition of market efficiency is the absence of arbitrage opportunities, then having been eliminated by arbitrage. Thus arbitrage is an act of buying an asset/ security in one market and selling simultaneously in another market. This restores equilibrium in markets which are temporarily out of equilibrium. One who engages in arbitrage is called the arbitrager. American Depository Receipts (ARDS) : These are depository receipts issued by a company in USA and are governed by the provisions of Securities and Exchange Commission of USA. As the regulations are severe, Indian companies tap the American market through private debt placement of GDRS listed in London and Luxemberg stock exchanges. Apart from the legal impediments, ADRS are costlier than Global Depository Receipts (GDRS). Legal fees are considerably high for US listing. Registration fee in USA is also substantial. Hence ADRS are less popular than GDRS. Random work Theory: It is generally believed that stock market prices can never be predicted because they are not a result of any underlying factors but are mere statistical ups and downs. This hypothesis is known as Random Walk Hypothesis. According to this theory there is no relation ship between present prices of shares and their future prices. It is argued that stock market prices are independent. M.G. Kendell found that changes in security prices behave nearly as if they are generated by a suitably designed roulette wheel for each outcome is statistically independent of past history. Successive peaks and troughs in prices are unconnected. In laymans language it may be said that prices on the stock exchange behave exactly the way of drunk would behave while going in a blind lane- up and down with an unsteady gait going in any direction he likes, bending backward and forward going on sides now and then.

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10. Financial swaps: Financial swaps are a finding technique which permit a borrower to access one market and then exchange the liability for another type of liability. Investors can exchange one type of asset for another with the preferred income stream. Swaps by themselves are not a funding instrument, they are a device to obtain the desired form of financing indirectly which otherwise might be inaccessible or too expensive. All swaps involve exchange of a series of periodic payment between two parties, usually through an intermediary which is a large international financial institution. The two payment streams are estimated to have identical present value at the outset when discounted at the respective cost of funds in the relevant primary financial markets. The two major types of financial swaps are interest rate swaps and currency swaps. The two are combined to give a cross-currency interest rate swap. A number of variations are possible within each major type. In the following para the concept of interest rate and currency swaps has been described. Interest rate swaps: Within an interest rate swap, interest-payment obligations are exchanged between two parties, but they are dominated in the same currency. The swap can be longer term in nature than either the forward or the future contracts. Terms extend out of 15 years more, whereas the range for forward or future contracts is upward to five year. The market for swaps is unregulated and began in the early 1980s. The most common interest rate swap is the floating-fixed rate exchange. For example, a corporate that has borrowed on a fixed rate, term basis may swap with a counter party t make floating rate interest payments.

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Currency swaps: Yet another device for shifting risk is the currency swap. In a currency swap, two parties exchange debt obligations denominated in different currencies. Each parties agrees to pay the others interest obligation. At maturity, principle amounts are exchanged, usually at a rate of exchanged agreed upon in advance. The currency swap market traces its roots to the 1960s, when parallel loans were arranged between two borrowers of different nationalities. In currency swaps both the principal and interest in one currency are swapped for principal and interest in another currency. On maturity the principal amounts are swapped back. Usually in practice swap is intermediate by a bank which takes away a part of the savings, leading the balance to be shared by the parties. Swap gains or losses arises because of spread compression which varies in different financial markets. 11. Zero Coupon Bonds: These are bonds issued at a deep discount to their face value. Their redemption will be at par on maturity and no interest coupon in between is admissible. The initial discount is so calculated to give a yield to maturity consistent to prevailing market alternatives. Zero coupon bonds are generally issued to arbitrage tax barrier. In addition investors in Zero coupon bonds have a view that interest rates are on a declining trend-hence by buying zero coupons they buy instruments which not only lock in current market yields but also take into account the reinvestment of interest received back at the current yield. These bonds are also known as pure discount bonds. (a) SEBI: The Securities and Exchange Board of India (SEBI) is the nodal agency formed under an Act of Parliament i.e. (SEBI Act), 1992. The Act, is extended to whole of India and has come into force on 30th January, 1992. SEBI is entrusted with the task of regulating capital markets and related issues in India. This has been established after the repeal of the Capital Issues Control Act, 1947. SEBI has formulated a basic set of guidelines for Disclosure and Investor Protection in 1992. These guidelines form the core of SEBIs regulation and cover various aspects such as pricing, promoters contribution, lock-in-period, credit rating etc. Euro Issues: The Government of India, as a part of liberalisation and de-regulation of industry and to augment the financial resources of companies, has allowed companies to directly tap foreign resources for their requirements. The liberalised measures have boosted the confidence of foreign investors and provided an opportunity to Indian companies to explore the possibility of tapping the International capital market for their financial requirements, where the resources are raised through the mechanism of Global Depository Receipts (GDRs). A depository receipt basically a negotiable certificate, denominated in US dollars, that represents a non-US companys publicly-traded local currency (Indian rupee) equity shares. The depository receipt can also represent a debt instrument. During the first half of the fiscal year 1994-95, Indian companies mobilised more than $1 billion through GDR and Euroconvertible bond issues. The guidelines for Euro-issues-1994-95 were announced by the Government on May 11, 1994. However, the Finance Ministry has reviewed recently the guidelines applicable to Euro-issues. The major features of Euro-issues are :1.The issue is in foreign currency. 2.The issue is to investors outside India. 3.It is underwritten and traded in by international syndicate of banks/financial institutions. The reasons for sudden spurt in such issues are:1.European market are flushed with funds. 2.Euro investors are looking for higher yield than that available locally. 3.Opening up of the Indian economy. Explain the various steps involved in financial planning. Briefly speaking the first step involved in financial planning is to lay down both long term and short term objectives. The short term objective may be to optimise the shareholders wealth. The second step in the financial planning is formulation of policies which will guide to all actions for procuring and disbursing funds to business firms. The third step is collection of facts and forecasting the future. This steps is closely related to formulation of policies. Forth step involved is formulation of procedures. Each procedure should be detailed enough to ensure consistency in action. Each person involved in the process should know what he is supposed to do. The next is to provide room to revise the policies or completely change the same to take advantage of changing conditions. In other words, financial planning covers the following aspects. (i) Determining of financial objectives- As started above, the financial objectives of an organisation may be divided into short-term and long-term objectives. The sort term objectives may be in respect of maintaining the liquidity, proper maintenance of sale etc., whereas the long term objectives of financial planning may be to secure and employ resources in the requisite amount and in the desired proportion to increase the efficiency of other factors of production.

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(ii) Formulation of financial policies- Policies are guides to decision making for achieving the firms primary objectives. Some of the important policies may be regarding capitalisation, capital structure, trading on equity, fixed assets management, divided distribution and working capital management. These policies cover the areas of procuring, administering and distributing the funds of the business enterprise, and may specifically be spelt out to govern the capitalisation, debt-equity ratio, sources of funds, administration and distribution of funds collection of debts and extending credit etc., and extent of control to be exercised by the suppliers of funds. (iii) Designing financial procedures- A procedure helps in the practical implementation of decision taken by the finance manager. During the course of financial planning it is also necessary to design and develop procedures involving funds which are helpful in the achievement of the firms objectives. In developing financial procedures, the finance manager will decide about the control system, develop standards of performance, evaluate the performance and then compare the activities with the standards. Since evaluation is a continuous process, the finance manager has to be very vigilant. To ensure the best possible use of funds the finance manager may employ the techniques of capital budgeting, financial forecasting, and financial analysis like ratios and budgetary control, etc. 15. Use of Matrix Approach in Investment Decisions: Management of investment portfolio is a complex task and involves a large number of variables. Some essential but conflicting considerations in this context are liquidity , safety, yield and image of the investment. Over the years investment managers have been looking for a rational and systematic approach to find the right balance along such factors. One of the available approaches in this regard is referred to as the matrix approach. Under this method, marks or weights are allotted to each of the competing factors and are finally aggregated for each type of investment. All illustrative matrix for 3 alternatives of investment is given below:Investment Liquidity Safety Yield Image Total (Max. 100) (Max. 100) (Max. 100) (Max. 100) (Max400) 1. Fixed deposit with Public sector bank 100 100 60 100 360 2. Fixed deposit with a 80 70 90 80 320 private sector company 3. Debentures of a private 50 100 70 80 300 sector company A logical ranking is possible from the above approach. However, one criticism that is possible in respect of matrix approach is that there could be some element of subjectivity in the award of the marks and that the approach is not free of defects. 16. Discuss any five factors to be considered in the choice of investment. (a) The following are the important factors which are required to be considered in the choice of investments: (i) Security: Whenever a person invests his funds, he would require that his investments are safe. These means that the principal amount and the return thereon would be redeemed when due. Safety of funds is the primary objective of portfolio management. Therefore, it is a must for the investors or portfolio managers to ensure that their investments are safe and will return with appreciation in value. (ii) Liquidity: An investor would like that his investments should remain as liquid as possible so that in case of need, he can encash them without loss of time and value. Therefore, an investor has no consider the liquidity aspect while making investments. He has to match the maturity schedule of investments with his needs. (iii) Return: Every investor invests with a view to get good reasonable return on his investments. This is one of the prime considerations in taking an investment decision. Certain investments carry fixed rate of return, namely, bank deposits, debentures, public deposits etc., and there are other investments, namely, shares of company, which do not carry fixed rate of return. An investor has to decide whether he would like to have fixed and regular return or the is prepare to have fluctuating return on his investments. Accordingly, he will decide about the investments. (iv) Risk: Risk is inherent in all the investments. Risk and return have direct relationship. Higher the risk, higher the return. If one wishes to have higher return from his investments he should be prepare to carry higher risk also. For example, if one wishes to double his investment in one year, he can do so by purchasing high risk shares, in which case, there is a great amount of risk that he may loose even his initial investments. Every investor has to consider his aspect while deciding about investment portfolio. By proper judgement and intelligence one can reduce the element of risk to the extent possible. Proper planning and periodical review of market situation can help in minimising the risk.

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(v) Growth: This is very crucial to decide what type of securities an investor would like to have in his investment portfolio. The investor is very much concerned with appreciation in the value of his investment. This also determines the ultimate profitability of his investments. There are wide variety of investments available, i.e., debentures, convertible bonds, preference shares, equity shares, Government Securities, Mutual Funds, etc. Some of these are fixed return bearing securities. These ensure a definite return and thus have a lower risk of return. However, if investments are made in shares or convertible debentures of a good company, sufficient appreciation (growth) many be caused in the value of investments after the lapse of a reasonable time. 16. Higher the return, higher will be the risk . In this context discuss the various risk associated with portfolio planning. Answer: There are four different types of risks in portfolio planning. 1. Interest rate risk : It is due to changes in interest rates from time to time. Price of the securities move invertly with change in the rate of interest. 2. Purchasing power risk : As inflation affects purchasing power adversely. Inflation rates vary over time and the investors are caught unaware when the rate of inflation changes abruptly. 3. Business risk : It arises from sale and purchase of securities affected by business cycles and technological changes. 4. Financial risk : This arises due to changes in the capital structure of the company. It is expressed in terms of debt-equity ratio. Although a leveraged companys earnings are more, too much dependence on debt financing may endanger solvency and to some extent the liquidity.

Miscellaneous 1. Indicators of social desirability of a project: In the context of project evaluation, it is not sufficient that a project should only be commercially variable but it should also be socially desirable. (1) Employment potential criterion: Projects which have higher employment potential are naturally preferred, partially in developing countries. (2) Capital output ratio: This ration shows the value of expected output in relation to the capital employed. Under this criterion, a project which gives a high output per unit of capital is ranked high. (3) Value added per unit of capital: In this, instead of taking the value of output, value added by the projects considered. It shows the net contribution of a project to the national economy, hence a good indicator for ranking projects according to their economic importance. (4) Foreign exchange benefit criterion: This seeks to evaluate the likely impact of a project on the overall balance of payments of the country. Project which promise to earn more of foreign exchange are given preference. (5) Cost benefit ratio criterion: This criterion attempts to measure the total effect of all the social benefits and costs of a project. Considerations in selecting a depreciation policy: The following considerations must be kept in mind while selecting a depreciation policy: (a) Tax implications: The income tax Act, 1961 prescribes the method of depreciation, namely, the diminishing balance method, it will have to prepare another statement for the computation of income for tax purposes, because the income calculated on the basis of straight-line method of depreciation will be different from that as computed on the basis of diminishing balance method recognised by the Income Tax Act. As such, if a company decides to follow any other method of depreciation than diminishing balance method, there would be a duplication of job of maintaining fixed assets accounts, computing depreciation and keeping the records according to both the methods of depreciation. (b) Impact of Dividend Distribution: The company cannot pay dividends except out of profits. Profits means surplus left after charging expenses and providing for depreciation under any of the recognised methods of depreciation. If the management decides to follow straight-line method of depreciation, the distributable surplus in the earlier years will be larger. This would enable the management to pay higher rate of dividend than it would have declared under diminishing balance method of depreciation, when its distributed surplus would have been comparatively less. Therefore, the management has to give adequate consideration to this matter. The rate of dividend has a direct bearing on the image of the company in the minds of the investors. Investors put their money in a particular company after assessing expected return from that company. (c) The cash flow Implications. No doubt, the quantum of depreciation is not going to affect the cash inflow from operations, because depreciation is not a source of funds. However, the quantum of depreciation does affect the availability of distributable surplus. The one method of depreciation may enable the company to have higher distributable profit or surplus than the other method.

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(d) Depreciation and Changes in Price Level: Depreciation being the process of allocation of historical cost over a number of years, the profit of any year is not the difference between the current revenue and the current cost. For, costs include depreciation as well, which is based on historical cost. This aspect should be taken into account while selecting the depreciation policy. (e) Cost of Replacement: One of the objectives of depreciation is to accumulate funds for replacement of old worn-out assets at the end of their useful life. This objective is not achieved, if company charges depreciation on the basis of historical cost because during inflation, price of the fixed assets go on increasing, and funds accumulated by depreciation may not be adequate to replace the worn-out asset. During inflation, the above objective may be achieved by charging depreciation on replacement cost basis. However, there are some difficulties in charging depreciation on replacement cost basis. Therefore, it may be taken into consideration as to how the extra funds are to be provided to replace assets at a higher price. 3. Self insurance: Insurance decision is to pay off between the nature and quantum of risk that exists for an under taking and the amount of premium required to protect it against a particular risk. In large organisations with high asset value/ business paying insurance premium to outside agencies may be more expensive than probable loss that may reasonably occur. The example in this context may be of Railways, Transit insurance in a fertilizer company and Loss of Profit policy in a company with less or no accident. In such organisations, a provision may be made and an insurance fund created. In the year of loss the insurance fund shall be used to compensate the loss. Hence in large business, the decision to have insurance fund is an important one.

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Wealth maximisation with reference to society: The social concept will be maximised if the societys resources are optimally allocated. This will result in optimal capital formation and growth in the economy. This will also result in maximum economic welfare of the people. However, this may pose problem of finding out measure of efficiency. Sometimes there is a conflict of interest between a welfare state concept and productivity and efficiency. A via media should, therefore, be found to strike a balance taking into account the interest of society at large.

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Wealth maximisation and value maximisation objective of financial management: It is commonly believed that maximisation of profit is the basis objective of a business enterprise. But in a study of business finance, it is argued that profit maximisation is too narrow as an objective, since it does not take into account the extent of risk, the timing of returns and certain other important factors such as obligation to workers, consumers, society and ethical trade practices. Wealth maximisation is argued out to be a better and more appropriate objective than profit maximisation. The tern wealth maximisation in this context is used to refer to the process of using resources to yield economic values higher than the values of inputs. Even if the management has other motives, such as increase in sales or market share these operating goals do not necessarily conflict with the goal of wealth maximisation. It is, therefore, said that maximisation of wealth provides a useful and meaningful objective for arriving at financial decisions. In the corporate business environment, if the company maximises its wealth for a given set of inputs, the increase in wealth does not automatically reach the shareholders the owners; this can materialise only when the value of the share is maximised. This gives rise to the relevance of the theory of value maximisation. According to Van Horne, the market price of a firms stock represents the final judgement of all market participants as to what the value of the particular firm is. It takes into account present and prospective future earnings per share, the timing and risk of these earnings, the dividend policy of the firm and many other factors that bear upon the market price of the stock. The market price serves as a performance index or report card of the firms progress; it indicates how well management is doing on behalf of stockholders Arguably thus, value maximisation is a complete objective with reference to which financial decisions are to be taken. Causes of industrial sickness: The Tiwari Committee appointed by the Government of India to into industrial sickness in India. The Committee has broadly classified such causes into internal and external causes. Among the internal causes inadequate technical know how, location disadvantage, outdated production process, high cost of inputs, break even point too high, uneconomic size of project, under-estimation of financial requirements and unduly large investments in fixed assets are some of the causes which may be mentioned in this respect. Beside this the dependence on a single customer and the limited number of products, poor sales realisation, defective pricing policy, booking of large orders at fixed prices under inflationary conditions, lack of knowledge of marketing techniques, etc., are leading to the industrial sickness in India. The poor resources management and faulty financial management policies like wrong dividend policy and faulty costing etc. are also contributing to industrial sickness. Among the external causes identified by the committee are, government price control, fiscal duties, frequent changes in government policies, procedural delays on the part of

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financial/licensing/other controlling or regulating authorities (Banks, RBI, Financial Institutions, Government Departments, MRTP authorities etc.).Besides this natural calamities, political situation (domestic as well as international ), strikes and multiplicity of labour unions are also responsible for industrial sickness in India. 8. Types of Insurance Cover regarding business operations: Certain business risks associated with business operations are insurance company enables a firm to transfer various business risks to it under the contract of insurance cover are: (i) Fire Insurance: This insurance against loss of property due to fire. This comes with associated risk covers such as explosion, floods, burglary, riot, strike, etc. (ii) Loss of profits Insurance: Cessation of business or any part thereof due to any reason may cause loss profits to the firm. For example, if property housing a factory is damaged by fire, it may result in the factory not being able to operate for sometime and cause loss and profit. This can be insured under fire policy or separately under a loss of profits policy. (iii) Transit Insurance: This is insurance of transit or transport risks of goods/cash which is very important to any business. It includes land, sea and air transport of goods/cash. Marine insurance occupies an important place in the business world. Cash in transit policy covers risk to cash when carried from one place to another. (iv) Accident Insurance: This saves the business from loss that might arise due to accidents and injury. In this, various other types of insurance which are not covered by life, fire or marine, can be covered. (v) Public Liability Insurance: Claims of third parties for damages or loss against the firm are covered by this type of insurance. (vi) Fidelity Guarantee Insurance: This protects the employer from the loss caused through defalcation by a dishonest employee. In addition to the above, there are many other types of policies dealing with damages in specific contingencies. The businessman can protect himself against the various business risks by taking a suitable insurance policy. 9. Common size statements: One useful way of analysing financial statements is to convert them into common size statements by expressing absolute rupee amounts into percentages. In case of the income statement, all items of expense are exhibited in percentages as a percentage of sales. Sales are taken at 100%. Similarly in balance sheet each individual asset and liability is shown as a percentage of total Assets/ Liabilities. Common size statements prepares for a firm/company over the years would highlight the relative changes in each group of expenses, assets and liabilities. These statements are very useful in inter-firm comparisons. An illustration of common size statement regarding the Profit and Loss Statement of X Ltd. is given below: Profit and Loss Statement Net Sales 100% Cost of goods sold 50% Gross profit 50% Selling, administration and general expenses 25% PBIT 25% Interest 10% PBT 15% Tax 7% PAT 8% 10. Inflation and financial management : Financial management is basically conserned with the proper management of finance which is regarded as the life blood of business enterprise. The direct consequence of inflation has been to distort the significance of operating results and utility of financial statements (based on historical cost) for various managerial accounting and decision making purposes. Even through it is beyond the scope of finance manager to control inflation. He, however, tries to measure the impact of inflation on his business so as to re-orient various financial management policies according to the fact changing circumstances. Some of the prominent areas which are affected by inflation and are required to be re-oriented are as follows : Financing decisions : This involves identifying the sources from which the finance manager should raise the quantum of funds required by a company. The debentureholder and preference shareholders are interested in fixed income while equity shareholders are interested in higher profits to earn high dividend. The finance manager is required to estimate the amount of profits he is going to earn in future. While estimating the revenue and costs, he must take into consideration the inflation factor.

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Investment decisions : The capital budgeting decisions will be biased if the impact of inflation is not correctly factored in the analysis. This is because the cash flows of an investment project occur over a long period of time. Therefore, the finance manager should be concerned about the impact of inflation on the projects profitability. Working Capital decisions : The finance manager is required to consider the impact of inflation while estimating the requirements of working capital. This is because of the increasing input prices and manufacturing costs, more funds may have to be tied up in inventories and receivables. Dividend payout policy : This involves the determination of the percentage of profits earned by the enterprise which is to be paid to the shareholders. While taking this decision, the finance manager has to keep in mind the inflation factor. Therefore, while making this decision he has to see that the capital of the company remain intact even after the payment of dividend. This is because in a inflationary situation the depreciation provided on the basis of historical costs of assets would not provide adequate funds for replacement of fixed assets at the expiry of their useful lives. 11. Briefly indicate the cause of industrial sickness in India.

Answer : Causes of Industrial sickness : The causes of industrial sickness in India may be broadly classified as follows : A. Internal causes : Under this category , the following causes are generally responsible . for the industrial sickness in India . Planning (a) Technical feasibility : Viz. Inadequate technical know how, locational disadvantage , out date production process. (b) Economic viability : High cost of inputs, break even point too high , uneconomic size of project, under estimation of the financial requirements unduly large investment in fixed assets, over -estimation of demand , poor labour relations, lack of trained / skilled labour or technically competent personnel . (c) Marketing management : Dependence on single customer or a limited number of customers / single or a limited number of products , poor sales realisation defective pricing policy booking of large order at fixed price in an inflationary market , weak market feedback and market research. Lack of knowledge of marketing techniques, unscrupulous sales / purchase practices. (d) Financial management : Poor resources management and financial planning , faulty costing , liberal dividend policy, general financial indiscipline and application of funds for unauthorised purpose, deficiency of funds , over trading unfavourable gearing or keeping adverse debt equity ratio, inadequate working capital , absence of cost consciousness, lack of effective collection machinery. (e) Administrative management : Over centralisation, lack of professionalism, lack of feed back to management . (2) Implementation : Cost over -runs resulting from delays in getting licences / sanctions , etc., inadequate mobilisation of finance . (3) Functional management (a) Production management : Inappropriate product mix , poor quality control, high cost of production, poor inventory management, inadequate maintenance and replacement, lack of timely and adequate modernisation , etc., high wastage, poor capacity utilisation. (b) Labour management relations : Excessively high wage structure, inefficient handling of labour problems, excessive manpower, poor labour productivity , lack of proper management information system and controls, lack of timely diversification excessive expenditure on Research 7 Development, dividend loyalties ( where the same management has interest in more than one unit , cases are known where promoters of limited companies who also have their own private interests first tend to look after the interest of the latter , often at the cost of the former ) dissension within the management, incompetent and dishonest management. B. External causes and other factors : The following factors may be mentioned in this respect. Government controls and policies etc. : Government price controls, fiscal duties, abrupt changes in Government policies affecting costs / prices / imports / exports / licensing . (b) Procedural delays on the part of financial / licensing / other controlling or regulating authorities like Banks, RBI, Financial Institutions, Government departments, Licencing Authorities, MRTP authorities , etc. (c) Market constraints : Market saturation , Revolutionary technological advances rendering the products obsolete, and Recession fall in domestic / export demand (d) Extraneous factors : Natural calamities, Political situation (domestic as well as international), and Strikes and multiplicity of labour unions etc.

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4. 5.

7. 8.

Special features of Financial Management in a public sector undertaking (PSUs) : Role of financial advisor :The financial advisor occupies an important position in public . sector undertakings. His concurrence is required on all proposals which have financial . implications. Capital budgeting decisions : The power upto certain limits, in respect of individual capital expenditure items has been delegated to the board of public sector undertakings. Board which appraises and recommends projects to the Central Government. Capital structure decisions : Such decisions involves the identification of different sources of finance. Normally PSUs are financed on the basis of half of their capital being in the shape of equity and in the shape of loans. The funds are also provided to PSUs directly by the government. The following factors are taken into consideration at the time of designing capital structure (I) gestation period (ii) level of business risk (iii) capital intensity of project and (iv) freedom of pricing. Working capital management : The inventory constitutes a major portion of the working capital of public sector undertakings and hence proper inventory management should be given top priority by public sector undertakings. Audit : Public sector undertakings in addition to regular audit conducted by professional accountants, are subject to efficiency cum propriety audit by the Comptroller and Auditor General of India whose reports are presented to parliament every year . Annual report : The annual reports of public sector units though similar to those of private sector units, tend to provide more information. Pricing policy : The bureau of public sector undertaking has laid down certain guidelines for pricing by PSUs with the objective to serve the overall interest of the community at large . Status of public sector undertaking : PSUs are organised mainly as departmental enterprise or statutory corporation or companies. Just-In-Time (JIT) System The JIT system was developed at the Toyota Motor Company in Japan. Since then many progressive corporations the world over have been implementing JIT. The major application to date of JIT has been in repetitive industries : auto, electronics, machinery, appliances, and so on. The JIT inventory systems are also referred to as zero inventory or stockless production systems. Unlike conventional systems where inventory is treated as an asset, the JIT system views inventory as the root of all evil. In traditional organisations a high level of inventory is held to cover up the problem areas related to quality, vendor delivery, machine breakdowns, etc. The JIT approach is the opposite. The inventory level is lowered to expose the real organisational problems and attempts are made to solve the problems at their points of incipience. In JIT, the master schedule (or final assembly schedule) is planned for 1 to 3 months into the future to allow work centres and vendors to plan their respective work schedules. Within the current month, the master schedule is levelled on a daily based. In other words, the same quantity of each product is produced each day for the entire period of three months. Furthermore, small lots (preferably, in size of 1) are scheduled in the master schedule to provide a uniform load on the plant and vendors during each day. The advantage of this kind of master scheduling is that it provides nearly constant demands on all downstream work centres and vendors. The JIT system uses a simple but powerful parts withdrawal system (called Kanban) to pull parts from one work centre to the next. Parts are kept in small containers and only a specific number of these containers are provided. When all the containers are filled, the machines are shut off, and no more parts are produced until the subsequent (using) work centre provides another empty container. Thus, work-inprogress inventory is limited to available containers and parts are only produced as needed. The final assembly schedule pulls parts from one work centre to the next just in time to support production needs. If a process stops because of machine breakdown or quality problems, all processes will automatically stop when their parts containers become full. The objective of JIT is to produce parts in a lot size of 1. In many cases, this is not economically feasible because of the cost of set up compared with inventory carrying cost. The JIT solution to this problem is to reduce the set up time as much as possible, ideally to zero. The set up time is not taken as given, but rather considered a cause of excess inventory. Low set up times result in small, economical lot sizes and shorter production lead times. Reducing the set up time for machines is a key to the JIT system. With shorter lead times and less material in process, the production system is also much more flexible to

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changes in the master schedule. This also means that the organisation is in a better position to respond to changes taking place in the market. With an emphasis on quick changeovers and smaller lots, the multifunction works is required. Crosstraining is needed so that a worker can switch from one machine to the next and so that workers can perform their own set up and maintenance. This requires a broader range of skills than traditional manufacturing. The JIT system requires not only broader skills, but much greater teamwork and coordination since inventory is not available to cover up problems in the system. The layout of the plant is much different with a JIT system since inventory is held on the shop floor and not put in a storeroom between processes. Inventory is kept out in the open, so it is readily available to the next process. Since inventory is typically kept low only a few hours of supply plants can be kept mush smaller. Quality is absolutely essential for a JIT system. Quality problems grind the production process to a halt. Since there is no inventory to cover up for mistakes, perfect quality is required by a JIT system. The JIT system, however, facilities very good quality since defects are quickly discovered by the next process. Quality problems rapidly gain plantwide attention as the production line stops when problems occur. A JIT system is designed to expose errors and get them corrected rather than to cover them up with inventory. Finally, vendor relations are radically changed by a JIT system. Vendors are asked to make frequent deliveries (as many as four times per day) directly to the production line. Vendors receive Kanban containers, just as in-plant work centres do, since vendors are viewed as an extension of the plant. Changes in shipping procedures and close proximity of vendors are often required to integrate vendors effectively with JIT procedures. Vendors are also required to delivery perfect quality. A revolution is required in the way that we usually think of vendors; we need to think of them as partners rather than as adversaries. As can be seen, the JIT system affects practically every aspect of plant operations. While the effects are far-reaching, so are the potential benefits. Inventory turns of 50 or 100 times per year, superior quality, and substantial cost advantages 915 to 25 per cent less) have been reported. As has been discussed above, there is nothing culturally inherent in the JIT system which prevents Indian companies from using the JIT system or improving on it. Many Indian companies are committed to making JIT work as a matter of economic survival. 14. Electronic Data Interchange and bar Coding Recent technological advances like Electronic data Interchange (EDI) and bar Coding are likely to make significant changes in the way we have been managing inventories. The EDI is a direct computer-to-computer exchange of information normally provided on standard business documents such as purchase orders, invoices, etc. With such a direct communication linkage with a supplier, a buyer can obtain price quotes, determine availability of items in a suppliers tock, transmit a purchase order, obtain follow-up information, provide the supplier information about changes in purchases requirements caused by schedule revisions, obtain service information, and send letters and memos all instantly. Without the EDI, such business transactions depend on the exchange of paper documents. Doing away with the cumbersome process of exchanging paper documents results in timely accurate information, greater administrative efficiency, and improved quality of decision making. Through the implementation of EDI is still in a nascent stage in India, with rapid advances in telecommunication technology it is likely to become popular in the future. Bar coding identifies products using machine-readable codes. The bar code technology allows faster and more accurate data entry, better document tracking, and reduced inventory cost. Bar codes are printed patterns of lines, spaces, and numerals we see on some of the imported packaged goods. bar codes are useful to the manufacturer as they are to the retailer. The purpose is to keep an accurate count of inventory items as they move past a scanner. With the help of bar coding, companies have decreased inventory investment by 10 to 15 per cent reduced clerical errors to almost zero, and increased the ability to give accurate inventory counts and product information to concerned managers. In India several

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manufacturing organisations and many departmental enterprises have enterprises have already stated using bar codes.