Financial Management is that specialised function of general management which is

related to the procurement of finance and its effective utilisation for the
achievement of common goal of the organisation.
It includes each and every aspect of financial activity in the business. Financial
Management has been defined differently by different scholars. A few of the
definitions are being reproduced below:-

Financial Management is an area of financial decision making harmonizing
individual motives and enterprise goals.- Weston and Brigam.

Financial Management is the application of the planning and control functions to
the finance function.- Howard and Upton.

Financial Management is the operational activity of a business that is responsible
for obtaining and effectively, utilizing the funds necessary for efficient operations.-
Joseph and Massie.

From the above definitions, it is clear that financial management is that specialized
activity which is responsible for obtaining and affectively utilizing the funds for the
efficient functioning of the business and, therefore, it includes financial planning,
financial administration and financial control.

The executive finance function is so termed because it
requires some administrative skill in planning, execution and
control. On the other hand incidental finance function is so called
because it does not require any specialized administrative skill
and for the most part it covers routine work, mainly clerical that
is necessary to carry into effect the executive decisions. We shall
discuss hereunder both the finance functions of finical
management in detail.
Executive Finance Functions
Executive finance functions include all those financial decisions of importance which require specialized
administrative skill.
Some of the executive functions are given below:-

(i) Financial Forecasting. The first and foremost functions of financial management is to forecast
the financial needs of the concern. In the initial stage, it is done by promoters but in a going concern,
it is generally performed by the executive chief or by the officers of the finance-department in a large
scale enterprise. In estimating the financial requirements of the concern, help of various budgets i.e.,
sales budget, production budget etc., profit and loss account and Balance Sheet is sought.

(ii) Establishing Asset-Management Policies. In order to estimate and arrange for cash
requirements of an enterprise, it is very necessary to decide how much cash will be invested in non-
cash assets, i.e., fixed assets, and also the kind and coverage of insurance that a company will carry.
Establishing a sound asset management policy is a pre-requisite to successful financial Management.
No doubt the financial manager in deciding about the asset-management policies seeks cooperation of
marketing executive in making decisions involving the carrying of inventories of finished goods and
credit policy etc. and that of the production manager in making decision concerned with the carrying
of inventories of raw materials and factory supplies, purchases etc.

(iii) Allocation of Net Profit. How to allocate the net profits of the concern is the another problem
before the financial manager. After paying all taxes, the available net profits of the concern can be
allocated for three purposes- (a) For paying dividends to the shareholders of the comp nay as a return
upon this investment. (b) for distributing bonus to the employees and company's contribution tooth
profit sharing plans, and (c) retention of profits for the expansion of business. As far as, the second
alternative is concerned, the amount to be paid to employees is generally fixed by statutes or on
contractual basis and therefore, there is no problem in allocating profits for that purpose. But a
considerably attention is to be paid in so far as first and third alternatives are concerned namely the
dividends to be distributed to the shareholders and the amount to be retained for future expansion
plans.

(iv) Cash Flows and Requirements. It is the prime responsibility of the financial manager to see
that an adequate supply of cash is available at proper time for the smooth running of the business. A
good financial executive should ensure that cash inflow and outflow must be continuous and
uninterrupted. Inflow of cash originates in sales and cash outflows or cash requirements are closely
related to volume of sales. Here the financial manger is to decided how much cash e must retain to
meet the current obligations so that there would be no idle cash balance earning nothing for the
company. But there is a dilemma because inflow of cash is not precisely predictable and seldom offset
one another. Therefore, the financial manager must maintain a balance between inflow of cash and
outflow of cash.

(v) Deciding Upon Borrowing Policy. Every organisation plans for the expansion of the business
for which he requires additional resources. Personal resources being limited the case must be
arranged by borrowing money either from commercial bank, and other financial institutions or by
floating new debentures or by issuing new shares. The financial manger, at this juncture, will take a
decision about the time when the funds from outside sources are needed, the source from which they
are to be received, how log they will be needed an from what source they will be repaid. Obviously, it
is a very important function of financial manager.

(vi) Negotiations For New outside Financing. Finance function does not stop with the decision to
undertake outside financing; it extends towards carrying on negotiations from the outside financing
agencies to arrange for it. Finances are needed by an establishment to meet its short-term and long-
term requirements. The financial manger must assess short and long term financial requirements of
the organization a start negotiations for raising these funds. It requires considerable planning because
the sources are to be tackled in advance keeping in view the alternative sources and sounded in a
manner that in case one fails, the other should be available. He must keep open the credit lines.

(vii) Checking upon Financial Performance. The Financial manager is under an obligation to check
the financial performance of the funds invested in the business. It requires retrospective analysis of
the operating period to evaluate the efficiency of financial planning. An unbiased assessment of
financial performance shall be great value to the business in improving the standards, techniques, and
procedures of financial control.

Incidental Finance functions are those functions of clerical or routine nature which
are necessary for the execution of decisions taken by the executives. Some of the
important incidental finance functions are:-

(a) supervision of cash receipts an disbursements an safeguarding of cash
balance.

(b) Proper custody and safeguarding of the important and valuable papers,
securities and insurance policies.

(c) Taking care of all mechanical details of financing.

(d) Record-keeping and reporting.
(e) Cash planning a credit management.

The above incidental functions are self-explanatory and require no explanation,


Objectives of Financial Management
Finance functions-both executive and incidental-are there in an organisation to achieve certain
financial objectives.
The objectives or goals or financial management are- (a) Profit maximization, (b)
Return maximization, and (c) Wealth maximization. We shall explain these three
goals of financial management as under:

(1) Goal of Profit maximization. Maximization of profits is generally regarded as
the main objective of a business enterprise. Each company collects its finance by
way of issue of shares to the public. Investors in shares purchase these shares in
the hope of getting medium profits from the company as dividend It is possible only
when the company's goal is to earn maximum profits out of its available resources.
If company fails to distribute higher dividend, the people will not be keen to invest
their money in such firm and persons who have already invested will like to sell
their stocks. On the other hand, higher profits are the barometer of its efficiency on
all fronts, i.e., production, sales an management. A few replace the goal of
'maximization of profits' to 'fair profits'. 'Fair Profits' means general rate of profit
earned by similar organisation in a particular area.

(2) Goal of Return Maximization. The second goal of financial management is to
safeguard the economic interest of the persons who are directly or indirectly
connected with the company, i.e.,shareholders, creditors and employees. The all
such interested parties must get the maximum return for their contributions. But
this is possible only when the company earns higher profits or sufficient profits to
discharge its obligations to them. Therefore, the goal of maximization of returns are
inter-related.

3. Goal of Wealth Maximization. Frequently, Maximization of profits is regarded
a the proper objective of the firm but it is not as inclusive a goal as that of
maximising it value to its shareholders. Value is represented by the market price of
the ordinary share of the company over the long run which is certainly a reflection
of company's investment and financing decisions. The log run means a considerably
long period in order to work out a normalized market price. The management ca
make decision to maximize the value of its shares on the basis of day-today
fluctuations in the market price in order t raise the market price of shares over the
short run at the expense of the long fun by temporarily diverting some of its funds
to some other accounts or by cutting some of its expenditure to the minimum at
the cost of future profits. This does not reflect the true wort of the share because it
will result in the fall of the share price in the market in the long run. It is, therefore,
the goal of the financial management to ensure its shareholders that the value of
their shares will be maximized in the long-run. In fact, the performances of the
company can well be evaluated by the value of its share.

Importance of financial management
In a big organisation, the general manger or the managing director is the overall incharge of the
organisation but he gets all the activities done by delegating all or some of his powers to men in the
middle or lower management, who are supposed to be specialists in the field so that better results
may be obtained.
For example, management and control of production may be delegated to a man
who is specialist in the techniques, procedures, and methods of production. We ma
designate him Production Manager'. So is the case with other branches of
management, i.e., personnel, finance, sales etc.

The incharge of the finance department may be called financial manger, finance
controller, or director of finance who is responsible for the procurement and proper
utilisation of finance in the business and for maintaining co-ordination between all
other branches of management.

Importance of finance cannot be over-emphasised. It is, indeed, the key to
successful business operations. Without proper administration of finance, no
business enterprise can reach its full potentials for growth and success. Money is a
universal lubricant which keeps the enterprise dynamic-develops product, keeps
men and machines at work, encourages management to make progress and creates
values. The importance of financial administration can be discussed under the
following heads:-

(i) success of Promotion Depends on Financial Administration. One of the
most important reasons of failures of business promotions is a defective financial
plan. If the plan adopted fails to provide sufficient capital to meet the requirement
of fixed and fluctuating capital an particularly, the latter, or it fails to assume the
obligations by the corporations without establishing earning power, the business
cannot be carried on successfully. Hence sound financial plan is very necessary for
the success of business enterprise.

(ii) Smooth Running of an Enterprise. Sound Financial planning is necessary for
the smooth running of an enterprise. Money is to an enterprise, what oil is to an
engine. As, Finance is required at each stage f an enterprise, i.e., promotion,
incorporation, development, expansion and administration of day-to-day working
etc., proper administration of finance is very necessary. Proper financial
administration means the study, analysis and evaluation of all financial problems to
be faced by the management and to take proper decision with reference to the
present circumstances in regard to the procurement and utilisation of funds.

(iii) Financial Administration Co-ordinates Various Functional
Activities. Financial administration provides complete co-ordination between
various functional areas such as marketing, production etc. to achieve the
organisational goals. If financial management is defective, the efficiency of all other
departments can, in no way, be maintained. For example, it is very necessary for
the finance-department to provide finance for the purchase of raw materials and
meting the other day-to-day expenses for the smooth running of the production
unit. If financial department fails in its obligations, the Production and the sales will
suffer and consequently, the income of the concern and the rate of profit on
investment will also suffer. Thus Financial administration occupies a central place in
the business organisation which controls and co-ordinates all other activities in the
concern.
(iv) Focal Point of Decision Making. Almost, every decision in the business is
take in the light of its profitability. Financial administration provides scientific
analysis of all facts and figures through various financial tools, such as different
financial statements, budgets etc., which help in evaluating the profitability of the
plan in the given circumstances, so that a proper decision can be taken to minimise
the risk involved in the plan.

(v) Determinant of Business Success. It has been recognised, even in India
that the financial manger splay a very important role in the success of business
organisation by advising the top management the solutions of the various financial
problems as experts. They present important facts and figures regarding financial
position an the performance of various functions of the company in a given period
before the top management in such a way so as to make it easier for the top
management to evaluate the progress of the company to amend suitably the
principles and policies of the company. The financial manges assist the top
management in its decision making process by suggesting the best possible
alternative out of the various alternatives of the problem available. Hence, financial
management helps the management at different level in taking financial decisions.

(vi) Measure of Performance. The performance of the firm can be measured by
its financial results, i.e, by its size of earnings Riskiness and profitability are two
major factors which jointly determine the value of the concern. Financial decisions
which increase risks will decrease the value of the firm and on the to the hand,
financial decisions which increase the profitability will increase value of the firm.
Risk an profitability are two essential ingredients of a business concern.

Profit-Maximization Vs. Wealth Maximizations
We have discussed above the goals of financial management. Now the question
arises of the choice, i.e., which should be the goal of decision making be profit
maximization or which strengthen the case for wealth Maximization as the goal of
business enterprise.

The objections are:-

(i) Profit cannot be ascertained well in advance to express the probability of return
as future is uncertain. It is not at possible to maximize what cannot be known.

(ii) The executive or the decision maker may not have enough confidence in the
estimates of future returns so that he does not attempt future to maximize. It is
argued that firm's goal cannot be to maximize profits but to attain a certain level or
rate of profit holding certain share of the market or certain level of sales. Firms
should try to 'satisfy' rather than to 'maximize'

(iii) There must be a balance between expected return and risk. The possibility of
higher expected yields are associated with greater risk to recognise such a balance
and wealth Maximization is brought in to the analysis. In such cases, higher
capitalisation rate involves. Such combination of expected returns with risk
variations and related capitalisation rate cannot be considered in the concept of
profit maximization.

(iv) The goal of Maximization of profits is considered to be a narrow outlook.
Evidently when profit maximization becomes the basis of financial decisions of the
concern, it ignores the interests of the community on the one hand and that of the
government, workers and other concerned persons in the enterprise on the other
hand.

Keeping the above objections in view, most of the thinkers on the subject have
come to the conclusion that the aim of an enterprise should be wealth Maximization
and not the profit Maximization. Prof. Soloman of Stanford University has handled
the issued very logically. He argues that it is useful to make a distinction between
profit and 'profitability'. Maximization of profits with a vie to maximising the wealth
of shareholders is clearly an unreal motive. On the other hand, profitability
Maximization with a view to using resources to yield economic values higher than
the joint values of inputs required is a useful goal. Thus the proper goal of financial
management is wealth maximization.

Meaning of Financial Planning
Financial planning means deciding in advance, the financial activities to be carried
on to achieve the basic objective of the firm. The basic objective of the firm is to
get maximum profits out of minimum efforts.
So, the basic purpose of the financial planning is to make sure that adequate funds
are raised at the minimum cost (optimal financing)and that they are used wisely.
Thus planners of financial policies must see that adequate finance are available with
the concern, because an inadequate supply of funds will hamper operations and laid
to difficulties. Too much capital, on the other hand, means lower earnings to the
unit holders. A proper planning is therefore necessary.
Main Aspects of Financial Planning
There are mainly three aspects:
(1) Determining Financial Objectives. The main aspect of financial planning is
to determine the long-term ad the short-term financial objectives. Determining of
financial objectives is necessary to achieve the basic objectives of the firm.
Financial objectives guide the financial authorities in performing their duties well.
Financial objectives may be long-term and short-term. The long-term financial
objective of the firm should be to utilise the productive resources of the firm
effectively and economically. The effective utilisation of all other productive factors
is possible only if there is a regular supply of funds at minimum cost. Thus long
therm financial objectives include (a) proper capitalisation, i.e., to estimate the
amount of capital to be raised and (b) determining the capital structure, i.e, the
form, relationship and proportionate amount of securities to be issued.

(2) Formulating Financial Policies. The second aspect of financial planning is to
formulate certain policies to be followed by the financial authorities with regard to
the administration of capital to achieve the long-term and the short-term financial
objectives of the firm. The following financial policies maybe important in regard to-
i. Policies regarding estimation of capital requirements.
ii. Policies regarding relationship between the company and
creditors.
iii. Policies regarding the form and proportionate amount of
securities to be issued.
iv. Policies and guidelines regarding sources of raising capital.
v. Policies regarding distribution of earnings.
(3) Developing Financial Procedures. The third aspect of financial planning is to
develop the procedure for performing the financial activities. For this purpose,
financial activities should be sub-divided into smaller activities and powers, duties
and responsibilities be delegated to the sub-ordinate officers. Proper control on
financial performance should also be administered. Financial control is possible by
establishing standards for evaluating the performance and comparing the actual
performance with the standard so established. Stern steps should be taken to
control any deviations from or inconsistencies in predetermined objectives, policies
and programmes. Various methods are used for this purpose such as budgetary
control, cost-control, analysis and interpretation of financial accounts etc.
Characteristics of a sound financial plan
The success of a business very much depends upon a financial plan (capital plan)
based upon certain basic principles of corporation finance.
The essential characteristics of an ideal capital plan may briefly be summarised as
follows:-

(1) Simplicity. The capital plan of a company should be as simple as possible. By
'simplicity' we mean that the plan should be easily understandable to all and it
should be free from complications, and/or suspicion-arising statements. At the time
of formulating capital structure of a company or issuing various securities to the
public, it should be borne in mind that there would be no confusion in the mind of
investors about their nature and profitability.

(2) Foresight. The planner should always keep in mind not only the needs of
'today' but also the needs of 'tomorrow' so that a sound capital structure (financial
plan) may be formed. Capital requirements of a company can be estimated by the
scope of operations and it must be planned in such a way that needs for capital
may be predicted as accurately as possible. Although, it is difficult to predict the
demand of the product yet it cannot b an excuse for the promoters to use foresight
to the best advantage in building the capital structure of the company.

(3) Flexibility. The capital structure of a company must be flexible enough to
meet the capital retirements of the company. The financial plan should be chalked
out in such a way that both increase and decrease in capital may be feasible. The
company may require additional capital for financing scheme of modernisation,
automation, betterment of employees etc. It is not difficult to increase the capital.
It may be done by issuing fresh shares or debentures to the public or raising loans
from special financial institutions, but reduction of capital is really a ticklish problem
and needs statesman like dexterity.

(4) Intensive use. Effective us of capital is as much necessary as its procurement.
Every 'paisa' should be used properly for the prosperity of the enterprise. Wasteful
use of capital is as bad as inadequate capital. There must be 'fair capitalisation' i.e.,
company must procure as much capital as requires nothing more and nothing less.
Over-capitalisation and under capitalisation are both danger signals. Hence, there
should neither be surplus nor deficit capital but procurement of adequate capital
should be aimed at and every effort be made to make best use of it.

(5) Liquidity. Liquidity means that a reasonable amount of current assets must be
kept in the form of liquid cash so that business operations may be carried on
smoothly without any shock to therm due to shortage of funds. This cash ratio to
current ratio to current assets depends upon a number of factors, e.g., the nature
and size of the business, credit standing, goodwill and money market conditions
etc.

(6) Economy. The cost of capital procurement should always be kept in mind while
formulating the financial plan. It should be the minimum possible. Dividend or
interests to be paid to share holder (ordinary and preference) should not be a
burden to the company in any way. But the cost of capital is not the only criterion,
other factors should also be given due importance.

Capital and Capitalization
The term Capitalization is used only in relation to companies and not in respect of firms or sole-
proprietorships.
It is distinct from share capital which refer only to the paid-up value of shares
issued and definitely excludes bonds and other forms of borrowings. Similarly, it
should be distinguished form 'capital'. The term capital refers to the total
investment of a company in money, tangible assets like goodwill. It is in a way the
total wealth of a company. When used in the sense of net capital, it indicates the
excess of total assets over liabilities. Here, then, it includes the gains or profits
from the use and investment of the capital that has not been distributed to the
stockholders and excludes losses that have resulted from the use of capital.
Capitalization, on the other hand, refers only to the par value (i.e., face value
indicated on the security itself) of the long-term securities (shares and debentures)
plus by any reserves which are meant to be used for meting long-term and
permanent needs of a company. Thus 'capital' includes all the loans and reserves of
the concern but 'Capitalization' includes only longterm loans and retained profits
besides the capital.
Over-Capitalisation
If a company raises more capital (by the issue of shares and debentures and
through long-term loans) than is warranted by the figure of capitalisation of its
earning power, the company will be said to be over-capitalized.
In other words, a company is over-capitalized when its actual profits are not
sufficient to pay interest and dividends at proper rates. It follows that an over-
capitalized company is unable to pay a fair return on its capital investment. Thus if
a company earns Rs. 1,50,000 with the general expectation at 10 per cent,
capitalisation at Rs. 15,00,000 would b proper. But if the company, somehow,
issues shares and debentures to the extent of Rs. 25,00,000, the rat of earning will
be only 6 per cent because with surplus but idle funds profits will still remain Rs.
1,50,000. This company is over-capitalized. However, over-capitalisation is not
quite the same thing as excess of capital. A company is over-capitalized only
because the existing capital is not effectively utilised with the result that there is a
fall in the earning capacity, and consequently in the rate of dividend payable to
equity shareholders. This usually leads to a decline in the market value of the
shares. The chief sign of over-capitalizations is, therefore, a fall in the rate of
dividend over a long-term period. This means that over-capitalisation presents a
chronic conditions and is not based on the results of only a few years. To
emphasize this point, it may be stated that when a company has consistently
(regularly) been unable to earn the prevailing rate of return on its outstanding
securities (considering the earnings of similar companies in the same industry and
the degree of risk involved) it is said to be over-capitalized. Over capitalisation
results in the following ways:

(1) The enterprise may raise more money by issue of shares and debentures than
it can profitably use. In other words, there may be large amounts of idle funds with
the company. This may be done intentionally or unintentionally. Some companies,
for instance, are tempted by a favourable sentiment in the market, and issue too
large a number of shares.

(2) If a company borrows a large sum of money and has to pay a rate of interest
higher than its rate of earning, the results will be over-capitalisation. A major part
of the earnings may be given away to the creditors as interest,leaving little for the
shareholders. The rate of dividend is thus lowered and the market value of the
shares also declines.

(3) Over-capitalisation may often result when an excessive amount is paid for
goodwill and for fixed assets acquired from the vendor company or from promoters
or other people associated with the company, or when unduly high amounts are
spent on establishment. In such cases, the price paid for the requisition of a going
concern has no relation to its earning capacity.

(4) Sometimes a company acquires assets like plant, machinery and buildings
during a boom period. The price paid is naturally high. If the boom disappears and
a slump sets in, the real value of such assets will greatly decline and a large part of
the company's capital would be lost even though the books will still show the assets
an the capital at their previous figures. Such a company is over-capitalized because
its real earnings capacity will suffer a setback due to a fall in the value of assets,
whereas the capital will stand at its original figures.

(5) If a company does not make sufficient provision for depreciation and
replacement and distributes higher rates of profit amongst the shareholders, the
company will find after some time that, while the book value of assets is high, the
real, value is extremely low. The efficiency of the company is adversely affected
and its earnings go down thus bringing down the market value of the shares. This is
yet another case of over-capitalisation.

(6) High rates of taxation may leave little in the hands of the company to provide
for depreciation and replacement and dividend to shareholders. This may adversely
affect its earnings capacity and lead to over-capitalisation.
(7) When the promoters underestimate the capitalisation rate, the capitalisation
may not support the expected rate of earnings and over-capitalisation may result.
Suppose, a company's regular profit of rs. 50,000 is capitalized at 5% (i.e.,
capitalisation is Rs. 1,00,000), the rate which the promoters consider sufficient to
induce investors to buy the offered securities. If it is later on found that such
companies cannot command capital at less than 10% the correct capitalisation of
the profit of 10,000 will work out at
100
50,000 x ------, i.e., Rs. 5,00,000.
10

Theories of Capitalization
There are two recognized bases for capitalizing new companies
(i) Cost Theory: According to the cost theory of capitalization, the value of a
company is arrived at by adding up the cos of fixed assets like plants, machinery
patents, etc., the capital regularly required for the continuous operation of the
company (working capital), the cost of establishing business and expenses of
promotion. The original outlays on all these items become the basis for calculating
the capitalization of company. Such calculation of capitalisation is useful in so far as
it enables the promoters to kn ow the amount of capital to be raised. But it is not
wholly satisfactory. On import objection to it is that it is based o a figure (i.e., cost
of establishing and starting business) which will not change with variation in the
earning capacity of the company. The true value of an enterprise is judged from its
earning capacity rather than from the capital invested in it. If, for example, some
assets become obsolete (out of date) and some others remain idle, the earnings
and the earning capacity of the concern will naturally fall. But such a fall will not
reduce the value of the investment made in the company's business.


(ii) Earnings Theory: The earnings theory of Capitalization recognizes the fact
that the true value (capitalization) of an enterprise depends upon its earnings and
earning capacity. According to it, therefore, the value or Capitalization of a
company is equal to the capitalized value of its estimated earnings. For this purpose
a new company has to prepare an estimated profit and loss account. For the first
few year of its life, the sales are forecast ad the manager has to depend upon his
experience for determining the probable cost. The earnings so estimated may be
compared with the actual earnings of similar companies in the industry and the
necessary adjustments should be made. Then the promoters will study the rate at
which other companies in the same industry similarly situated are earnings. The
rate is then applied to the estimated earnings of the company for finding out the
capitalization. To take an example a company ma estimate its average profit in the
first few years at Rs. 50,000. Other companies of the same type are, let us assume,
earnings a return of 10 per cent on their capital. The Capitalization of the company
will then be
50,000 x 100
---------------- = Rs. 5,00,000.
10
It will be noted that the earnings basis for Capitalization has the merit of valuing
(capitalizing) a company at an amount which is directly related to its earning
capacity. A company is worth what it is able to earn. But it cannot, at the same
time be denied that new companies will find it difficult, and even risky, to depend
merely on estimate of their earnings as the generally expected return is an
industry. In case of new companies, therefore, the cost theory provides a better
basis for capitalisation than the earning theory.

In established concerns too, the Capitalization can be arrived at either (i) on the
basis of the cost of business, or (ii) the average or regular earnings and the rate of
return expected in an industry If cost is adopted as the basis, the Capitalization
may fall to reveal the true worth of a company. The assets of a company stand at
their original values while its earnings may have declined considerably. In such a
situation, it will be risky to believe that the Capitalization of the company is high.
Earnings, therefore, provide a better basis of Capitalization in established concerns
The figure will be arrived at in the same manner as above.

Actual and Proper Capitalization. The capitalisation of a company as arrived at by
totaling up the value of the shares, debentures and non-divisible retained earnings
of the company may be called the actual Capitalization of the company. Let us take
the relevant items in a company balance sheet for illustration. The actual
Capitalization as per balance sheet given below will be Rs. 16,00,000.

XYZ CO. LTD.
BALANCE SHEET AS ON 31
ST
DECEMBER, 1981
Liabilities Assets
Liabilities Assets
Paid-up capital Rs.

20,000 8 percent preference Shares of Rs.10 each 2,00,000

50,000 Shares of Rs. 8 each 4,00,000

10,000 Debentures of Rs. 100 each 10,00,000
---------------
16,00,000
--------------
Rs.
SundryAssets
16,00,000



------------
16,00,000
-----------



As against the actual Capitalization the proper, normal or standard Capitalization
for a company can be found out by capitalizing the average annual profits at the
normal rate of return earned by comparable companies in the same line of
business. Thus if a company gets an annual return of Rs. 1,50,000 and the normal
rate of return in the industry is 0 per cent, the proper Capitalization will be arrived
at as under:
100
1,50,000 x ------ = Rs. 15,00,000
10
A comparison between the actual and the proper on normal Capitalization will show
whether the company is properly capitalized, over-capitalized or under-capitalized.
Watered Capital
'Water' is said to be present in the capital when a part of the capital is not
represented by assets. It is considered to be as worthless as water. Sometimes the
services of the promoters are valued at an unduly high price.
Similarly, the concern may pay too high a price for an asset acquired from a going
concern. The capital becomes watered to the extent of the excess price paid for an
asset. Thus, if a company pays 1,25,000 on account of goodwill, which if valued
correctly is worth Rs. 50,000 only, the capital is watered to the extent of Rs.
75,000. 'Watered capital' must be distinguished from 'over capitalisation'. 'Water
enters the capital usually in the initial period-at the time of promotion. Over
capitalisation can, however, be found out only after the company has worked for
sometime. Although watered capital can be a cause of over-capitalisation, yet it is
not exactly the same thing. If the earnings are up to the general expection, a
concern will not be over capitalized even though a part of its capital is watered.
Under-capitalisation
Under-capitalisation is just the reverse of over-capitalisation. Sometimes a
company, on the face of it, may have an insufficient capital but it may have large
secret reserves.
Thus, in case of well-established companies, there is a very large appreciation in
the value of assets specially of buildings, plant and goodwill. Such appreciation is
generally not brought into the books. Nevertheless these assets do bring profits
and, therefor, the profits in such a company would appear to be much larger than
are warranted by the book figures of the capital. In such a case, the dividends will
be high and the market quotations of the shares of such companies will be higher
than the par value of the shares of other similar companies. It is in this sense that
an under-capitalized company pays high rats of dividend and the value of the
shares is higher than the par value. A company is under-capitalized when its actual
capitalisation(i.e., total long-term resources) is lower than its proper capitalisation
as warranted by its earning capacity. Such a company will earn considerable more
than the prevailing rate on its outstanding securities.
Disadvantages of under-capitalisation
Under-capitalisation, too, has its own disadvantages
(i) competition is encouraged and made acute by the higher earnings of such
companies

(ii) the high dividend rates given an opportunity to workers to ask for increase in
wages

(iii) it may give the consumers a feeling that they are being exploited by the
company
(iv) it may tempt the management to manipulate share values|

(v) it may limit the marketability of shares due to which the shares may not enjoy
so high a market value as is justified by the earnings

(vi) it may attract governmental control and higher taxation. All or some of these
factors may act together to reduce the margin of profit earned by the company. In
course of time, then, the earnings of the company may come down to the level of
other companies' earnings. Under-capitalisation of this type may thus be temporary
in character and often gets remedied automatically.
Remedies of under-capitalisation
If it is desired to remedy under-capitalization, it can be done relatively more easily
than in the case of over-capitalization.
The possible corrections for under-capitalisation may be outlined as under:
(i) Spliting-up of shares. The effect of this measure will be more apparent than real
because the overall rate of earnings in this case will remain the same though the
dividend per share will now b e a smaller amount.

(ii) Increase in par value of shares. The values of assets, under this scheme, may
be revised upwards and the existing shareholders may be given new shares
carrying higher par (face) value. In this way, the rate of earnings will decline
though the amount of dividend per share may not be affected. As a further step,
the com pay may offer the shareholders a share split-up and an increase in par-
value.

(iii) Issue of bonus shares. The most widely used and effective remedy for under
capitalisation is the conversion of reserves into shares. This will affect both dividend
per share and the over-all rate of earnings.


Trading on equity
The term 'equity' means stock or ordinary shares of a company and 'trading means
taking an advantage of. Hence trading on equity means taking advantage of
ordinary equity share capital to borrow fund on reasonable basis.
It is an additional advantage to equity shares at the expense of other forms of
securities. It is based on the basic principle that there is a difference among the
rates of return on different types of securities issued by a company.

A company earns its profits at a fixed rate on capital employed by it, whether it is
ownership capital, i.e., raised from shareholders or borrowed capital. Borrowed
capital, i.e., debentures, bonds etc. (including preference capital) is fixed cost
bearing capital and a fixed rate of interest and dividend is to be paid on such
securities. If this fixed rate of interest and dividend is lower than the general rat of
company's earnings, the equity shareholders will have an advantage of this
situation in the form of additional profit because there is no fixed rate of dividend
on equity shares. If company earns higher profits, equity shareholders will have an
advantage of this situation in the form of additional profit because there is no fixed
rate of dividend on equity shares. If company earns higher profits, equity
shareholders will get higher dividend on their investments or vice versa. This is
referred to as 'Trading on Equity'. Thus trading on equity is an arrangement under
which company makes use of borrowed capital carrying a fixed rate of interest or
dividend in such a way as to increase the rate of return on equity shares. A
company can substantially increase the rate of dividend on equity shares by issuing
debentures or preference shares. On the other hand, if entire capital of the
company is issued in the form of equity shares, the rate of dividend on these shares
can in no case exceed the general rate of earnings of the company. This can be
illustrated with the help of an example

Suppose, a company likes to have a total investment of Rs. 1,00,00, on which it
would earn a profit at the rate of 10%,i.e., Rs. 1,00,000. If the company raises its
entire capital by issues of equity shares, the equity shareholders cannot earn a
dividend exceeding 10% But, suppose, the company raises the funds in the
following manner.

(a) Rs. 5,00,000 by issue of debentures bearing 6 % interest

(b) Rs. 2,00,000 by issue of preference shares carrying 8% dividend
(c) Rs. 3,00,000 by issue of ordinary shares.

In such case, out of the profit of Rs. 1,00,000, company will have to pay Rs. 30,000
as interest to the debenture holders and Rs. 16,000 as dividend to preference
shareholders and thus leaving a balance of Rs. 54,000 for paying dividend to equity
shareholders. Since the amount of equity capital is only Rs. 3.00,000 the rate of
dividend on such shares can be 18% In this way, by issuing debentures and
preference shares, the rate of dividend on equity of trading or equity is substantial.
These is another advantage that shares pay increased income tax as interest paid
on debenture is deductible under Income Tax Act.
.
Debt equity ratio
Capitalisation of a company consists of funds raised by issuing various types of
securities, i.e.,ordinaryshares, preference shares, debentures etc.
To decide as to the ratio of various types of securities to total capitalisation is a
very difficult task but the decision in this important for the business to decide as to
the ratio of ownership capital to the creditorship capital or loan capital. The ratio of
borrowed capital to the owned capital may be called debt-equity ratio. In other
words, debt-equity ratio is the ratio between borrowed capital on the one hand and
owned capital on the other.

Debt-equity ratio is positively correlated with the capital gearing. If capital gearing
in a company is high, debt-equity ratio would also be high or vice versa. For
example, if the total capital of Rs. 1,00,000 in a company consists of Rs. 25,000
equity share capital and 75,000 debentures, the debt equity ratio in that company
would be 75000 : 25000 or 3 : 1
Factors of Working Capital
The following are the factors which determine a concerns requirements of working
capital
(i) The proportion of the cost of materials to total cost. In those industries
where cost of materials is a large proportion of the total cost of the goods produced
or where costly material will have to be used, requirements of working capital will
be rather large sums are required for this purpose. But if the importance of
materials is small, as for example, in an oxygen company, the requirements of
working capital will naturally be small.

(ii) Importance of labour. This factor operates like the one mentioned above. If
goods are manufactured with the help of labour, large sums of money will have to
be kept invested as working capital. Industries where there is a great degree of
mechanisation, the working capital requirements are correspondingly small. It may
be remembered, however, that to some extent the decision to use manual labour or
machinery lies with the management. Therefore, it is possible in most cases to
reduce the requirements of working capital and increase investment in fixed assets
and vice versa.

(iii) Length of period of manufacture. The time which elapses between the
commencement and the end of the manufacturing process has an important
bearing upon the requirements of working capital. If it takes long to manufacture
the finished product, a large sum of money will have to be kept invested in the
from of work-in progress at all stages. Hence, working capital will be required in
large amounts. To give an example a baker requires a night's time to bake his daily
quota of bread. His working capital is, therefore, much less than that of a ship-
building concern which takes three to five years to build a ship.

(iv) Stocks. Manufacturing concerns generally have to carry stocks of raw
materials and other stores and also finished goods. In certain cases, manufacture is
carried out only against a definite order from a customer and as soon as production
in completed the gods are delivered to him. In this case, there will be no finished
stocks, and to this extent, the requirements, of working capital will be reduced. The
larger the stocks, whether of raw materials or finished goods, the larger will be the
requirement of working capital. To some extent, the size of stocks to be carried will
depend upon the decisions of management. Besides, the stocks to be carried are
generally proportionate to the volume of sales.
(v) Rapidity of turnover. Turnover represents the speed with which the working
capital is recovered by the sale of goods. In certain businesses, sales are made
quickly so that stocks are soon exhausted and new purchases have to be made. In
this manner, a small sum of money invested in stocks will result in sales of a much
larger amount. Considering the volume of sales the amount of working capital
requirements will be rather small in such types of businesses. There are other
business where sales are made infrequently. For instance, in case of jewelers, a
piece of jewelery may stay in the show-window for a long time before it catches the
fancy of a rich lady. In such cases large sums o money have to be kept invested in
stocks. But a baker or a new-hawker may be able to dispose of his socks quickly,
and may, therefore, need much smaller amounts by way of working capital.

(vi) Terms of Credit. It goes without saying that if credit is allowed by suppliers,
payment can be postponed for some time and can be made out of the sale proceeds
of the goods produced. In such a case, the requirements of working capital will be
reduced. The requirements will obviously be increased if credit has to be allowed to
customer. The period of credit also determined the working capital requirements of
a concern. If, for example, a retailer is allowed credit for a longer period than is
allowed by him to his own customers, he would not need much working capital
because he can pay the supplier after he has collected debts from his

Standard Debt Equity Ratio
It is very difficult to fix a standard for the debt equity ratio. It depends very much
on the circumstances. However, a standard of debt equity ratio may be 1 :1 but it
does not always hold good. In the present circumstances, the debt equity ratio has
been on increase.
It increased from 45.8% to 65.5% in 1975. In a developing country like India,
where wealth has concentrated in a few hands, the whole of the capital cannot be
raised through risk capital because only few have risk bearing capacity and most of
the investors want to invest their funds in fixed income bearing securities such as
preference shares or debentures. It has become inevitable in these circumstances
that company issues debentures to raise the necessary funds for the expansion and
modernisation of its developmental plans. Also, in order to attract the investing
people who prefer fixed income rather than uncertain income, company issues
debentures or bonds with attractive terms.

The assumption that low debt equity ratio denotes soundness of the company is not
always correct in the present circumstances High debt equity ratio in some
companies is not an indication of financial stringency if thy are in a position to earn
profits at a higher rate than the rate of interest payable on the debt capital. It
means they are trading on equity and contributing something towards the funds
available for dividend to the equity shareholders. It strengthens the financial
position of the company inspite of the fact that company maintains high debt equity
ratio.

The nature of the business also affects the standard of debt equity ratio. Financial
companies such as banks, insurance companies, and other financial institutions
cannot survive without debt capital . Such companies maintain a very high debt-
equity ratio. In 1975, the equity ratio of scheduled banks in India was 13000 : 80.
Manufacturing companies can maintain a moderate debt equity ratio but a trading
company should depend more upon the ownership capital and this should maintain
a low debt equity ratio depending upon the nature of fixed capital.

Different types of Dividend
Dividend may be of different types. It can be classified according to the mode of its
distribution as follows

(1) Regular Dividend. By dividend we mean regular dividend paid annually,
proposed by the board of directors and approved by the shareholders in general
meeting. It is also known as final dividend because it is usually paid after the
finalization of accounts. It sis generally paid in cash as a percentage of paid up
capital, say 10 % or 15 % of the capital. Sometimes, it is paid per share. No
dividend is paid on calls in advance or calls in arrears. The company is, however,
authorised to make provisions in the Articles prohibiting the payment of dividend on
shares having calls in arrears.

(2) Interim Dividend. If Articles so permit, the directors may decide to pay
dividend at any time between the two Annual General Meeting before finalizing the
accounts. It is generally declared and paid when company has earned heavy profits
or abnormal profits during the year and directors which to pay the profits to
shareholders. Such payment of dividend in between the two Annual General
meetings before finalizing the accounts is called Interim Dividend. No Interim
Dividend can be declared or paid unless depreciation for the full year (not
proportionately) has been provided for. It is, thus,, an extra dividend paid during
the year requiring no need of approval of the Annual General Meeting. It is paid in
cash.

(3) Stock-Dividend. Companies, not having good cash position, generally pay
dividend in the form of shares by capitalizing the profits of current year and of past
years. Such shares are issued instead of paying dividend in cash and called 'Bonus
Shares'. Basically there is no change in the equity of shareholders. Certain
guidelines have been used by the company Law Board in respect of Bonus Shares.

(4) Scrip Dividend. Scrip dividends are used when earnings justify a dividend, but
the cash position of the company is temporarily weak. So, shareholders are issued
shares and debentures of other companies. Such payment of dividend is called
Scrip Dividend. Shareholders generally do not like such dividend because the shares
or debentures, so paid are worthless for the shareholders as directors would use
only such investment is which were not . Such dividend was allowed before passing
of the Companies (Amendment) Act 1960, but thereafter this unhealthy practice
was stopped.

(5) Bond Dividends. In rare instances, dividends are paid in the form of
debentures or bounds or notes for a long-term period. The effect of such dividend is
the same as that of paying dividend in scrips. The shareholders become the secured
creditors is the bonds has a lien on assets.

(6) Property Dividend. Sometimes, dividend is paid in the form of asset instead
of payment of dividend in cash. The distribution of dividend is made whenever the
asset is no longer required in the business such as investment or stock of finished
goods.

But, it is, however, important to note that in India, distribution of dividend is
permissible in the form of cash or bonus shares only. Distribution of dividend in any
other form is not allowed.

Factors Affecting Dividend Policy
A number of considerations affect the dividend policy of company. The major
factors are
1. Stability of Earnings. The nature of business has an important bearing on the
dividend policy. Industrial units having stability of earnings may formulate a more
consistent dividend policy than those having an uneven flow of incomes because
they can predict easily their savings and earnings. Usually, enterprises dealing in
necessities suffer less from oscillating earnings than those dealing in luxuries or
fancy goods.

2. Age of corporation. Age of the corporation counts much in deciding the
dividend policy. A newly established company may require much of its earnings for
expansion and plant improvement and may adopt a rigid dividend policy while, on
the other hand, an older company can formulate a clear cut and more consistent
policy regarding dividend.

3. Liquidity of Funds. Availability of cash and sound financial position is also an
important factor in dividend decisions. A dividend represents a cash outflow, the
greater the funds and the liquidity of the firm the better the ability to pay dividend.
The liquidity of a firm depends very much on the investment and financial decisions
of the firm which in turn determines the rate of expansion and the manner of
financing. If cash position is weak, stock dividend will be distributed and if cash
position is good, company can distribute the cash dividend.

4. Extent of share Distribution. Nature of ownership also affects the dividend
decisions. A closely held company is likely to get the assent of the shareholders for
the suspension of dividend or for following a conservative dividend policy. On the
other hand, a company having a good number of shareholders widely distributed
and forming low or medium income group, would face a great difficulty in securing
such assent because they will emphasise to distribute higher dividend.

5. Needs for Additional Capital. Companies retain a part of their profits for
strengthening their financial position. The income may be conserved for meeting
the increased requirements of working capital or of future expansion. Small
companies usually find difficulties in raising finance for their needs of increased
working capital for expansion programmes. They having no other alternative, use
their ploughed back profits. Thus, such Companies distribute dividend at low rates
and retain a big part of profits.

6. Trade Cycles. Business cycles also exercise influence upon dividend Policy.
Dividend policy is adjusted according to the business oscillations. During the boom,
prudent management creates food reserves for contingencies which follow the
inflationary period. Higher rates of dividend can be used as a tool for marketing the
securities in an otherwise depressed market. The financial solvency can be proved
and maintained by the companies in dull years if the adequate reserves have been
built up.
7. Government Policies. The earnings capacity of the enterprise is widely affected
by the change in fiscal, industrial, labour, control and other government policies.
Sometimes government restricts the distribution of dividend beyond a certain
percentage in a particular industry or in all spheres of business activity as was done
in emergency. The dividend policy has to be modified or formulated accordingly in
those enterprises.


8. Taxation Policy. High taxation reduces the earnings of he companies and
consequently the rate of dividend is lowered down. Sometimes government levies
dividend-tax of distribution of dividend beyond a certain limit. It also affects the
capital formation. N India, dividends beyond 10 % of paid-up capital are subject to
dividend tax at 7.5 %.

9. Legal Requirements. In deciding on the dividend, the directors take the legal
requirements too into consideration. In order to protect the interests of creditors an
outsiders, the companies Act 1956 prescribes certain guidelines in respect of the
distribution and payment of dividend. Moreover, a company is required to provide
for depreciation on its fixed and tangible assets before declaring dividend on
shares. It proposes that Dividend should not be distributed out of capita, in any
case. Likewise, contractual obligation should also be fulfilled, for example, payment
of dividend on preference shares in priority over ordinary dividend.

10. Past dividend Rates. While formulating the Dividend Policy, the directors
must keep in mind the dividend paid in past years. The current rate should be
around the average past rat. If it has been abnormally increased the shares will be
subjected to speculation. In a new concern, the company should consider the
dividend policy of the rival organisation.
11. Ability to Borrow. Well established and large firms have better access to the
capital market than the new Companies and may borrow funds from the external
sources if there arises any need. Such Companies may have a better dividend pay-
out ratio. Whereas smaller firms have to depend on their internal sources and
therefore they will have to built up good reserves by reducing the dividend pay out
ratio for meeting any obligation requiring heavy funds.

12. Policy of Control. Policy of control is another determining factor is so far as
dividends are concerned. If the directors want to have control on company, they
would not like to add new shareholders and therefore, declare a dividend at low
rate. Because by adding new shareholders they fear dilution of control and
diversion of policies and programmes of the existing management. So they prefer
to meet the needs through retained earing. If the directors do not bother about the
control of affairs they will follow a liberal dividend policy. Thus control is an
influencing factor in framing the dividend policy.

13. Repayments of Loan. A company having loan indebtedness are vowed to a
high rate of retention earnings, unless one other arrangements are made for the
redemption of debt on maturity. It will naturally lower down the rate of dividend.
Sometimes, the lenders (mostly institutional lenders) put restrictions on the
dividend distribution still such time their loan is outstanding. Formal loan contracts
generally provide a certain standard of liquidity and solvency to be maintained.
Management is bound to hour such restrictions and to limit the rate of dividend
payout.

14. Time for Payment of Dividend. When should the dividend be paid is another
consideration. Payment of dividend means outflow of cash. It is, therefore,
desirable to distribute dividend at a time when is least needed by the company
because there are peak times as well as lean periods of expenditure. Wise
management should plan the payment of dividend in such a manner that there is
no cash outflow at a time when the undertaking is already in need of urgent
finances.

15. Regularity and stability in Dividend Payment. Dividends should be paid
regularly because each investor is interested in the regular payment of dividend.
The management should, inspite of regular payment of dividend, consider that the
rate of dividend should be all the most constant. For this purpose sometimes
companies maintain dividend equalization Fund.

Advantage to shareholders of Issue Bonus Share
Investors get the following advantages from bonus issue
(i) Tax-Saving. The stock dividend is not taxable as income in the hands of
shareholders while cash dividend is taxable as ordinary income.

(ii) Marketability of Shares. Shareholders who are in dire need of money sell
their stock dividend and pay capital gain taxes which is usually less than the income
tax on cash dividend. Thus, by issuing bonus shares, marketability of shares is
increased.

(iii) Higher Future Profits of the Company. The payment of stock dividend is
normally interpreted by shareholders as an indication of higher profitability. Stock
dividend is generally declared by the directors of the company only when they
expect rise in earnings to offset the additional outstanding shares. Thus, it may
convey some information which may have a favourable impact on the value of
shares.

(iv) Increased Future Dividend. In a company as been following a policy of
paying a fixed rate of dividend and continues if after issuing bonus shares, the
shareholders will get larger amount of cash dividend in future. Moreover, it may
have a favourable affect on the value of shares.

(v) Psychological Value. The declaration of stock dividend may have a favourable
psychological effect an shareholders. It gives an impression of prosperity of the
company. It helps to increase the capital value of shares in the market.








CAPITAL
BUDGETIN
G







The total capital (long-term and short term ) of a company is
employed in fixed and current assets of the firm. Fixed assets
include those assets which are not meant for sale such as land,
building, machinery etc. it is a challenging task before the
management to take judicious regarding capital expenditures, i.e.,
investments in fixed assets to that the amount should not
unnecessarily be locked up in capital goods which may have fa-
reaching effects on the success or failure of an enterprise. A capital
asset, once acquired, cannot be disposed of without any substantial
loss and if it is acquired on long term credit basis, a continuing
liability is incurred over a long period of time, and will affect the
financial obligations of the company adversely. It, therefore,
requires a long-range planning while taking decision regarding
investments in fixed assets. Such process of taking decisions
regarding capital expenditure is generally known as capital
budgeting. In capital budgeting process, due consideration should b
given to the following problems-

(1) Problem of ranking project, i.e., choice of one project over other
project.
(2) Problem of capital rationing, i.e., limited budget resources.
(3) Limitations imposed by top management decision on the total
volume of investments to be made.

Now-a-days, however, some new analytical techniques are
developed for evaluating capital expenditure projects an are under
study.
More Notes on CAPITAL BUDGETING

CAPITAL STRUCTURE
Capital structure of a company refers to the make up of its
capitalisation. A company procures funds by issuing various types of
securities, i.e., ordinary shares, preference shares, bonds and
debentures. Before issuing any of these securities, a company
should decide about the kinds of securities to be issued. In what
proportion will the various kinds of securities be issued, should also
be considered. However, in broader sense, capital structure includes
all the long term capital resources including loans, bonds, share
issued, reserves, etc. and the components of the total capital. A
company engaged in devising a financial plan will be faced with
problem regarding the proportion of funds to be raised bu issue of
its shares and the amount to be raised though borrowings. There is
an important difference between these two methods. Funds raised
from shareholders require the payments of dividend only out of
profits of the company and the amount will be paid only out of
profits, if there is any, a company should maintain a fair balance
between these two types of securities-(a) fixed cost bearing
securities. (debentures and preference shares), and (b) Variable cost
bearing securities (ordinary shares). This security mix affects the
financial stability of the company. If a company fails in its efforts in
maintaining the security mix, its capital structure will be imbalanced
which may affect its profitability.
More Notes on CAPITAL STRUCTURE

CAPITALISATION
The term capitalization has been defined in a number of ways. As a
result, one finds almost as many definitions of the term as there are
writers on the subject. On careful analysis, however, one finds two
schools of thought on this concept. One of them assigns a broad
interpretation to the term, while the outer interprets it in a narrow
sense. In the following pages an attempt is mad to examine and
discuss the views of both these schools.
More Notes on CAPITALISATION

COST OF CAPITAL
The cost of capital is a very important factor in formulating a firm's
capital structure It is one of the corner-stones of the theory of
financial management, yet it is very controversial topic in finance. In
deciding the capital structure of a company, it is very necessary to
consider the cost of each source of capital and compare them so as
to decide which source of capital is in the interest of owners as well
as of the contributors, i.e., creditors etc. Now-a-days, cost of capital
is the major deciding factor of the capital structure. Prior to tis
development, cost of capital was either ignored or by passed. In
modern times, cost of capital is used as the very basis of capital
budgeting decisions or long term capital investment decisions and to
evaluate the alternative sources of capital. Different costs ae used in
different times and for different purposes.
More Notes on COST OF CAPITAL

DEPRECIATION POLICIES
In every day usage, the term depreciation denotes the decrease in
the value of tangible assets due to wear and tear, deterioration an
decay of assets with the passage of time, and damage or
destruction. It is treated as an expense and is charged against
profits of the concern. According to statutory provisions, charging of
depreciation to profit and loss account is a must in order to ascertain
the net profits available for the distribution of dividend to
shareholders. The provision of depreciation is also necessary to have
a true and fair view of the fixed assets of the company.

There are so many methods of providing depreciation on fixed asset
and the company is free to adopt any of these methods which suits
to6the needs of the business. But the method once adopted should
be followed throughout the life of the asset unless there is some
exceptional circumstances. The firm should establish a sound
depreciation policy taking in view the general principles of providing
depreciation and the statutory provisions relating to depreciation
because it affects considerably the profits, profitability and the
production capacity of to be concern. So, it is the responsibility of
the Finical executives to see whether the provision of adequate an
reasonable depreciation is being made or not.
More Notes on DEPRECIATION POLICIES

DIVIDEND POLICIES
Dividend is that portion of profits of a company which is distributed
among its shareholder according to the decision taken and resolution
passed in the meeting of Board of Directors. This may be paid as a
fixed percentage on the share capital contributed by them or at a
fixed amount per share. It means only profits after meeting all the
expenses and providing for taxation and for depreciation and
transferring a reasonal amount to reserve funds should be
distributed to shareholders as dividend. There is always a problem
before the top management or Board of Director to decide how much
profits should be transferred to Reserve funds to meet any
unforeseen contingencies and how much should be distributed to
shareholder,. Payment of dividend is desirable because it affects the
goodwill of the concern in the market on the one hand, and on the
other, shareholders invest their funds in the company in a hope of
getting a reasonable return. Retained earnings are the sources of
internal finance for the financing of corporate future projects but
payment of dividend constitute an outflow of ca to shareholders.
Although both-expansion and payment of dividend-are desirable,
these two are in conflicts. It is, therefore, one of the important
functions of the financial management to constitute a dividend policy
which can balance these two contradictory view paints and allocate
the reasonable amount of profits after tax between retained earnings
and dividend.
More Notes on DIVIDEND POLICIES

FUNDS FLOW AND CASH FLOW STATEMENTS
Every company prepares it balance sheet at the end of its
accounting year. It reveals the financial position of the company at a
certain point of time. It does not present any analysis. It is simply a
statement of assets and liabilities of the concern. Its usefulness is,
therefore, limited for analysis and planning purposes. The statement
of sources and application of funds serves the purpose, which is
popularly known as 'Funds Flow Statement'.

Funds-Flow-Statement is a widely used tool in the hands of financial
executives for analyzing the financial performance of a concern.
Good concerns always prepare such statement along with the
balance sheet at the end of year. This statement shows how the
activities of a business have been financed or how the available
financial resource have been used during a particular period. But it is
quite different from income statement which is primarily a
presentation of revenue and expenses items and computation of net
income for the period while the funds flow statement is a report of
financial operations of a business undertaking. It generally reports
changes in current assets and current liabilities and is much useful
for financial executives, financial institutions and creditor for the
analysis of financial position of the company.
More Notes on FUNDS FLOW AND CASH FLOW STATEMENTS

INSTITUTIONAL FINANCING OF INDUSTRY
Capital market comprises the sources of long-term finance for
industry and Government. It is the market that attracts savings from
various sources and makes them available to the sectors of the
economy requiring funds for productive uses the savings and to he
funds are converted into investments through the issue of new
securities by the Government, public bodies and industrial and
commercial companies. The major constituents of the capital market
are the savers and the bodies which mobilizes savings and chanalise
them into investment channels. Savers of funds may be individuals
or institutions and the mobilizers of savings includes savings banks,
investment trusts, specialised finance corporations and stock
exchanges. Prominent among he savings institutions investing in
industry is the Life Insurance Corporations and other insurance
companies, banks and finance corporations. The capital market
needs to be distinguished from the money market which is
concerned with the supply of short-term money to trade and
industry an from the discount market which consists in dealings in
bills of different kinds and supply of money to discount houses for
discounting of bills. The money market comprises the commercial
banks, exchange banks, co-operative banks, etc., and the central
bank (i.e., the Reserve Bank of India in India). The discount maker
consists of brokers, banks discounting bills, discount houses, etc.
In this lesson, we concern ourselves with those important
constituents of the capital market which serve to channelize funds
into industry by investing in the shares and debentures issued by
companies and otherwise.

These are:-
1. Investment Trusts
II. Unit Trust of India
III. LIC. and Insurance Companies
IV. Industrial Finance Corporation
V. State Finance Corporations
VI. The Industrial Credit and Investment Corporation
More Notes on INSTITUTIONAL FINANCING OF INDUSTRY

INTRODUCTION
Finance is the life-blood of modern business economy. We cannot
imagine a business without finance in the modern world. It is the
basis of all economic activities, no matter, the business is big or
small. The problem of finance and that of financial management is to
be dealt within every organisation. The problem of finance is equally
important to government, semi-governments and private bodies,
and to profit and non-profit organisations. It is therefore, essential
to clearly understand the meaning of financial management, its
scope and goals.
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MANAGEMENT OF INVENTORY
Inventories are the stocks of the product of a company and
components thereof that make up the product. The different forms
in which inventories exist are- raw materials, work in process (or
semi finished goods) and finished goods. Raw materials are those
inputs that are converted into finished product. Work in progress
inventories are semi-finished products. That requires more work
before they are ready for sale. Finished goods inventories are those
which are completely manufactured products and are ready for sale.
Raw materials and semi finished goods inventories facilitate
production while finished goods inventories are required for smooth
marketing operations. Thus inventories serve as a line between the
production and the consumption of goods.

Inventories constitute, in every business concern, the most
significant part of working capital or current assets. Inventories in
Indian industries constitute more than 60% of the current assets.
Inventories are significant elements in cost process. It is, therefore
essential to control the inventories. Inventories control is usually
used in two ways-unit or physical control and value control.
Purchase and production department officials use this wok in terms
of unit control because they are concerned only with the physical
control of the inventories. Where as in accounting department official
use it in terms of value control because
More Notes on MANAGEMENT OF INVENTORY

MARKETING AND UNDERWRITING OF SECURITIES
One of the important functions of Financial Management is the
marketing of securities of a company i.e., shares and debentures.
Marketing is a process which a company resorts to approach the
investing public for collecting funds for the company. For this
purpose, various methods and techniques are used. The problem of
marketing of securities arises for the first time when the company
comes into existence and collects funds by the issue of shares and
again at the time of subsequent issues of shares an debentures.
Trading in outstanding or old securities-shares and debentures-are
negotiable and the Stock Exchanges provide the continuous market
for the sale and purchase of securities in the process of mobilizing
savings of individuals, and institutions. For this purpose, a company
has to utilise the services of certain intermediaries which help the
company in selling, transferring, underwriting and sometimes in
direct subscribing the securities of the company. By marketing of
securities, here we mean, the primary distribution of securities by
the company at the time of its formation or at any time after its first
issue either direct or trough an underwriting agreement.
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PROBLEMS OF CASH MANAGEMENT
Cash management has very serious problems attached to it. We can
examine these problems under the following four heads:-
1. Controlling of level of cash,
2. Controlling inflow of cash,
3. Controlling outflow of cash
4. Optimal investment of surplus cash.
More Notes on PROBLEMS OF CASH MANAGEMENT

PROBLEMS OF NEW ISSUE
A company requires funds from time to time to meet its financial
requirements for expansion projects. For this purpose, company
issues securities-ordinary shares, preference shares or debentures.
While fissuring securities company faces so many problems as to:-

(i) How to market such securities-direct or through some
intermediaries or whether to underwrite the issue or hot.

(ii) What is the time of issuing securities, that should naturally be
the proper time to issue a particular security taking in view the stock
market conditions.

(iii) What price should be fixed or at what price at security should
be issued i.e., at par, at premium or at discount, i.e., problem of
pricing is there.

(iv) The problems attached to the rights issues.

The first problem i.e., the problem is of marketing and under
writing. The other three problems are the timing of issue, the pricing
of issue and the right issue.

The success of a new capital issue depends largely on as to how
these problems have been tackled: if the hurdles i these problems
have been overcome, the company will face no difficulty in raising
the funds to meet its needs properly otherwise they will imperil even
the existence of the company. Therefore, careful considerations are
needed