Q. Categorize business on the basis of ownership.

A. One of the first decisions that one has to make as a business owner is how the
business should be structured. This decision will have long-term implications, so
consult with an accountant and attorney to help you select the form of ownership that
is right for you. In making a choice, you will want to take into account the following:
* Your vision regarding the size and nature of your business.
* The level of control you wish to have.
* The level of structure you are willing to deal with.
* The businesss vulnerability to lawsuits.
* Tax implications of the different ownership structures.
* Expected profit (or loss) of the business.
* Whether or not you need to re-invest earnings into the business.
* Your need for access to cash out of the business for yourself.
These are the basic forms of business ownership:
1. Sole Proprietorship
A sole proprietorship is a business owned by only one person. It is easy to set-up and
is the least costly among all forms of ownership.
The owner faces unlimited liability; meaning, the creditors of the business may go
after the personal assets of the owner if the business cannot pay them.
The sole proprietorship form is usually adopted by small business entities.
2. Partnership
A partnership is a business owned by two or more persons who contribute resources
into the entity. The partners divide the profits of the business among themselves.
In general
partnerships, all
partners
have
unlimited
liability.
In limited
partnerships,creditors cannot go after the personal assets of the limited partners.
3. Corporation
A corporation is a business organization that has a separate legal personality from its
owners. Ownership in a stock corporation is represented by shares of stock.
The owners (stockholders) enjoy limited liability but have limited involvement in the
company's operations. The board of directors, an elected group from the stockholders,
controls the activities of the corporation.
4. Cooperative
A cooperative is a business organization owned by a group of individuals and is
operated for their mutual benefit. The persons making up the group are
called members. Cooperatives may be incorporated or unincorporated.
Some examples of cooperatives are: water and electricity (utility) cooperatives,
cooperative banking, credit unions, and housing cooperatives.
Q. Write a note on Finance function in an organization.
A. Financial Management means planning, organizing, directing and controlling the
financial activities such as procurement and utilization of funds of the enterprise. It
means applying general management principles to financial resources of the
enterprise.
Scope/Elements
1. Investment decisions includes investment in fixed assets (called as capital
budgeting). Investments in current assets are also a part of investment
decisions called as working capital decisions.
2. Financial decisions - They relate to the raising of finance from various resources
which will depend upon decision on type of source, period of financing, cost of
financing and the returns thereby.
3. Dividend decision - The finance manager has to take decision with regards to
the net profit distribution. Net profits are generally divided into two:
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a. Dividend for shareholders- Dividend and the rate of it has to be decided.

b. Retained profits- Amount of retained profits has to be finalized which will
depend upon expansion and diversification plans of the enterprise.
Objectives of Financial Management
The financial management is generally concerned with procurement, allocation and
control of financial resources of a concern. The objectives can be1. To ensure regular and adequate supply of funds to the concern.
2. To ensure adequate returns to the shareholders which will depend upon the
earning capacity, market price of the share, expectations of the shareholders?
3. To ensure optimum funds utilization. Once the funds are procured, they should
be utilized in maximum possible way at least cost.
4. To ensure safety on investment, i.e, funds should be invested in safe ventures so
that adequate rate of return can be achieved.
5. To plan a sound capital structure-There should be sound and fair composition of
capital so that a balance is maintained between debt and equity capital.
Functions of Financial Management
1. Estimation of capital requirements: A finance manager has to make
estimation with regards to capital requirements of the company. This will
depend upon expected costs and profits and future programmes and policies of
a concern. Estimations have to be made in an adequate manner which increases
earning capacity of enterprise.
2. Determination of capital composition: Once the estimation has been made,
the capital structure have to be decided. This involves short- term and longterm debt equity analysis. This will depend upon the proportion of equity capital
a company is possessing and additional funds which have to be raised from
outside parties.
3. Choice of sources of funds: For additional funds to be procured, a company
has many choices likea. Issue of shares and debentures
b. Loans to be taken from banks and financial institutions
c. Public deposits to be drawn like in form of bonds.
Choice of factor will depend on relative merits and demerits of each source and
period of financing.
4. Investment of funds: The finance manager has to decide to allocate funds
into profitable ventures so that there is safety on investment and regular returns
is possible.
5. Disposal of surplus: The net profits decision has to be made by the finance
manager. This can be done in two ways:
a. Dividend declaration - It includes identifying the rate of dividends and
other benefits like bonus.
b. Retained profits - The volume has to be decided which will depend upon
expansion, innovational, diversification plans of the company.
6. Management of cash: Finance manager has to make decisions with regards to
cash management. Cash is required for many purposes like payment of wages
and salaries, payment of electricity and water bills, payment to creditors,
meeting current liabilities, maintenance of enough stock, purchase of raw
materials, etc.
7. Financial controls: The finance manager has not only to plan, procure and
utilize the funds but he also has to exercise control over finances. This can be
done through many techniques like ratio analysis, financial forecasting, cost and
profit control, etc.

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Q. What are the decisions a finance manager needs to take as his recurring
or non-recurring duties?
A. The following explanation will help in understanding each finance function in detail
Investment Decision
One of the most important finance functions is to intelligently allocate capital to long
term assets. This activity is also known as capital budgeting. It is important to allocate
capital in those long term assets so as to get maximum yield in future. Following are
the two aspects of investment decision
a. Evaluation of new investment in terms of profitability
b. Comparison of cut off rate against new investment and prevailing investment.
Since the future is uncertain therefore there are difficulties in calculation of expected
return. Along with uncertainty comes the risk factor which has to be taken into
consideration. This risk factor plays a very significant role in calculating the expected
return of the prospective investment. Therefore while considering investment proposal
it is important to take into consideration both expected return and the risk involved.
Investment decision not only involves allocating capital to long term assets but also
involves decisions of using funds which are obtained by selling those assets which
become less profitable and less productive. It wise decisions to decompose
depreciated assets which are not adding value and utilize those funds in securing
other beneficial assets. An opportunity cost of capital needs to be calculating while
dissolving such assets. The correct cut off rate is calculated by using this opportunity
cost of the required rate of return (RRR)
Financial Decision
Financial decision is yet another important function which a financial manger must
perform. It is important to make wise decisions about when, where and how should a
business acquire funds. Funds can be acquired through many ways and channels.
Broadly speaking a correct ratio of an equity and debt has to be maintained. This mix
of equity capital and debt is known as a firms capital structure.
A firm tends to benefit most when the market value of a companys share maximizes
this not only is a sign of growth for the firm but also maximizes shareholders wealth.
On the other hand the use of debt affects the risk and return of a shareholder. It is
more risky though it may increase the return on equity funds.
A sound financial structure is said to be one which aims at maximizing shareholders
return with minimum risk. In such a scenario the market value of the firm will
maximize and hence an optimum capital structure would be achieved. Other than
equity and debt there are several other tools which are used in deciding a firm capital
structure.
Dividend Decision
Earning profit or a positive return is a common aim of all the businesses. But the key
function a financial manger performs in case of profitability is to decide whether to
distribute all the profits to the shareholder or retain all the profits or distribute part of
the profits to the shareholder and retain the other half in the business.
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Its the financial managers responsibility to decide a optimum dividend policy which
maximizes the market value of the firm. Hence an optimum dividend payout ratio is
calculated. It is a common practice to pay regular dividends in case of profitability
Another way is to issue bonus shares to existing shareholders.
Liquidity Decision
It is very important to maintain a liquidity position of a firm to avoid insolvency. Firms
profitability, liquidity and risk all are associated with the investment in current assets.
In order to maintain a tradeoff between profitability and liquidity it is important to
invest sufficient funds in current assets. But since current assets do not earn anything
for business therefore a proper calculation must be done before investing in current
assets.
Current assets should properly be valued and disposed of from time to time once they
become non profitable. Currents assets must be used in times of liquidity problems
and times of insolvency.

Q. What are the sources of long term and short term finance for a company?
A. Financing is a very important part of every business. Firms often need financing to
pay for their assets, equipment, and other important items. Financing can be either
long-term or short-term. As is obvious, long-term financing is more expensive as
compared to short-term financing.
There are different vehicles through which long-term and short-term financing is
made available. This chapter deals with the major vehicles of both types of financing.
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The common sources of financing are capital that is generated by the firm itself and
sometimes, it is capital from external funders, which is usually obtained after
issuance of new debt and equity.
A firms management is responsible for matching the long-term or short-term
financing mix. This mix is applicable to the assets that are to be financed as closely
as possible, regarding timing and cash flows.
Long-Term Financing
Long-term financing is usually needed for acquiring new equipment, R&D, cash flow
enhancement, and company expansion. Some of the major methods for long-term
financing are discussed below.
Equity Financing
Equity financing includes preferred stocks and common stocks. This method is less
risky in respect to cash flow commitments. However, equity financing often results in
dissolution of share ownership and it also decreases earnings.
The cost associated with equity is generally higher than the cost associated with
debt, which is again a deductible expense. Therefore, equity financing can also result
in an enhanced hurdle rate that may cancel any reduction in the cash flow risk.
Corporate Bond
A corporate bond is a special kind of bond issued by any corporation to collect money
effectively in an aim to expand its business. This tern is usually used for long-term
debt instruments that generally have a maturity date after one year after their issue
date at the minimum.
Some corporate bonds may have an associated call option that permits the issuer to
redeem it before it reaches the maturity. All other types of bonds that are known
as convertible bonds that offer investors the option to convert the bond to equity.
Capital Notes
Capital notes are a type of convertible security that are exercisable into shares. They
are one type of equity vehicle. Capital notes resemble warrants, except the fact that
they usually dont have the expiry date or an exercise price. That is why the entire
consideration the company aims to receive, for the future issuance of the shares, is
generally paid at the time of issuance of capital notes.
Many times, capital notes are issued with a debt-for-equity swap restructuring.
Instead of offering the shares (that replace debt) in the present, the company
provides its creditors with convertible securities the capital notes and hence the
dilution occurs later.
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Short-Term Financing
Short-term financing with a time duration of up to one year is used to help
corporations increase inventory orders, payrolls, and daily supplies. Short-term
financing can be done using the following financial instruments
Commercial Paper
Commercial Paper is an unsecured promissory note with a pre-noted maturity time of
1 to 364 days in the global money market. Originally, it is issued by large
corporations to raise money to meet the short-term debt obligations.
It is backed by the bank that issues it or by the corporation that promises to pay the
face value on maturity. Firms with excellent credit ratings can sell their commercial
papers at a good price.
Asset-backed commercial paper (ABCP) is collateralized by other financial assets.
ABCP is a very short-term instrument with 1 and 180 days maturity from issuance.
ABCP is typically issued by a bank or other financial institution.
Promissory Note
It is a negotiable instrument where the maker or issuer makes an issue-less promise
in writing to pay back a pre-decided sum of money to the payee at a fixed maturity
date or on demand of the payee, under specific terms.
Asset-based Loan
It is a type of loan, which is often short term, and is secured by a company's assets.
Real estate, accounts receivable (A/R), inventory and equipment are the most
common assets used to back the loan. The given loan is either backed by a single
category of assets or by a combination of assets.
Repurchase Agreements
Repurchase agreements are extremely short-term loans. They usually have a
maturity of less than two weeks and most frequently they have a maturity of just one
day! Repurchase agreements are arranged by selling securities with an agreement to
purchase them back at a fixed cost on a given date.
Letter of Credit
A financial institution or a similar party issues this document to a seller of goods or
services. The seller provides that the issuer will definitely pay the seller for goods or
services delivered to a third-party buyer.

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The issuer then seeks reimbursement to be met by the buyer or by the buyer's bank.
The document is in fact a guarantee offered to the seller that it will be paid on time
by the issuer of the letter of credit, even if the buyer fails to pay.

Q. What are the factors affecting choice of source of finance for an

organization?
A. Under the capital structure, decision the proportion of long-term sources of capital
is determined. Most favorable proportion determines the optimum capital structure.
That happens to be the need of the company because EPS happens to be the
maximum on it. Some of the chief factors affecting the choice of the capital structure
are the following:
(1) Cash Flow Position:
While making a choice of the capital structure the future cash flow position should be
kept in mind. Debt capital should be used only if the cash flow position is really good
because a lot of cash is needed in order to make payment of interest and refund of
capital.
(2) Interest Coverage Ratio-ICR:
With the help of this ratio an effort is made to find out how many times the EBIT is
available to the payment of interest. The capacity of the company to use debt capital
will be in direct proportion to this ratio.
It is possible that in spite of better ICR the cash flow position of the company may be
weak. Therefore, this ratio is not a proper or appropriate measure of the capacity of
the company to pay interest. It is equally important to take into consideration the cash
flow position.
(3) Debt Service Coverage Ratio-DSCR:
This ratio removes the weakness of ICR. This shows the cash flow position of the
company.
This ratio tells us about the cash payments to be made (e.g., preference dividend,
interest and debt capital repayment) and the amount of cash available. Better ratio
means the better capacity of the company for debt payment. Consequently, more
debt can be utilised in the capital structure.
(4) Return on Investment-ROI:
The greater return on investment of a company increases its capacity to utilize more
debt capital.
(5) Cost of Debt:
The capacity of a company to take debt depends on the cost of debt. In case the rate
of interest on the debt capital is less, more debt capital can be utilized and vice versa.
(6) Tax Rate:
The rate of tax affects the cost of debt. If the rate of tax is high, the cost of debt
decreases. The reason is the deduction of interest on the debt capital from the profits
considering it a part of expenses and a saving in taxes.
For example, suppose a company takes a loan of 0ppp 100 and the rate of interest on
this debt is 10% and the rate of tax is 30%. By deducting 10/- from the EBIT a saving
of in tax will take place (If 10 on account of interest are not deducted, a tax of @ 30%
shall have to be paid).
(7) Cost of Equity Capital:
Cost of equity capital (it means the expectations of the equity shareholders from the
company) is affected by the use of debt capital. If the debt capital is utilized more, it
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will increase the cost of the equity capital. The simple reason for this is that the
greater use of debt capital increases the risk of the equity shareholders.
Therefore, the use of the debt capital can be made only to a limited level. If even after
this level the debt capital is used further, the cost of equity capital starts increasing
rapidly. It adversely affects the market value of the shares. This is not a good
situation. Efforts should be made to avoid it.
(8) Floatation Costs:
Floatation costs are those expenses which are incurred while issuing securities (e.g.,
equity shares, preference shares, debentures, etc.). These include commission of
underwriters, brokerage, stationery expenses, etc. Generally, the cost of issuing debt
capital is less than the share capital. This attracts the company towards debt capital.
(9) Risk Consideration: There are two types of risks in business:
(i) Operating Risk or Business Risk:
This refers to the risk of inability to discharge permanent operating costs (e.g.,
rent of the building, payment of salary, insurance installment, etc),
(ii) Financial Risk:
This refers to the risk of inability to pay fixed financial payments (e.g., payment
of interest, preference dividend, return of the debt capital, etc.) as promised by
the company.
The total risk of business depends on both these types of risks. If the operating risk in
business is less, the financial risk can be faced which means that more debt capital
can be utilized. On the contrary, if the operating risk is high, the financial risk likely
occurring after the greater use of debt capital should be avoided.
(10) Flexibility:
According to this principle, capital structure should be fairly flexible. Flexibility means
that, if need be, amount of capital in the business could be increased or decreased
easily. Reducing the amount of capital in business is possible only in case of debt
capital or preference share capital.
If at any given time company has more capital than as necessary then both the
above-mentioned capitals can be repaid. On the other hand, repayment of equity
share capital is not possible by the company during its lifetime. Thus, from the
viewpoint of flexibility to issue debt capital and preference share capital is the best.
(11) Control:
According to this factor, at the time of preparing capital structure, it should be
ensured that the control of the existing shareholders (owners) over the affairs of the
company is not adversely affected.
If funds are raised by issuing equity shares, then the number of companys
shareholders will increase and it directly affects the control of existing shareholders. In
other words, now the number of owners (shareholders) controlling the company
increases.
This situation will not be acceptable to the existing shareholders. On the contrary,
when funds are raised through debt capital, there is no effect on the control of the
company because the debenture holders have no control over the affairs of the
company. Thus, for those who support this principle debt capital is the best.
(12) Regulatory Framework:
Capital structure is also influenced by government regulations. For instance, banking
companies can raise funds by issuing share capital alone, not any other kind of
security. Similarly, it is compulsory for other companies to maintain a given debtequity ratio while raising funds.
Different ideal debt-equity ratios such as 2:1; 4:1; 6:1 have been determined for
different industries. The public issue of shares and debentures has to be made under
SEBI guidelines.
(13) Stock Market Conditions:
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Stock market conditions refer to upward or downward trends in capital market. Both
these conditions have their influence on the selection of sources of finance. When the
market is dull, investors are mostly afraid of investing in the share capital due to high
risk.
On the contrary, when conditions in the capital market are cheerful, they treat
investment in the share capital as the best choice to reap profits. Companies should,
therefore, make selection of capital sources keeping in view the conditions prevailing
in the capital market.
(14) Capital Structure of Other Companies:
Capital structure is influenced by the industry to which a company is related. All
companies related to a given industry produce almost similar products, their costs of
production are similar, they depend on identical technology, they have similar
profitability, and hence the pattern of their capital structure is almost similar.
Because of this fact, there are different debt- equity ratios prevalent in different
industries. Hence, at the time of raising funds a company must take into consideration
debt-equity ratio prevalent in the related industry.

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