(UBA51) FINANCIAL MANAGEMENT

Transcription

1 (UBA51) FINANCIAL MANAGEMENT Unit-1 (INRODUCTION OF FINANCIAL MANAGEMENT) Type: 100% Theory Question & Answers PART A QUESTIONS 1. Define Financial Management. The term financial management has been defined by Solomon, It is concerned with the efficient use of an important economic resource namely, capital funds. 2. What is financial Planning? (April/May ) 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. 3. Define operating leverage.(april/may ) Operating leverage is a measure of a firm's level of fixed costs relative to its variable costs. A company with high degree of operating leverage has a larger ratio of fixed costs to variable costs, and as a result has a higher breakeven point. 4. What is financial forecasting? (April/2012) A financial forecast is simply a financial plan or budget for your business. It is an estimate of two essential future financial outcomes for a business your projected income and expenses. Create a cash flow forecast by adding income and expenses as they are due. 5. Define finance Function.(April2011) In the words of John J. Hampton, the term finance can be defined as the management of the flows of money through an organization, whether it will be a corporation, school, bank or government agency. MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 1 of 17

2 6. What is bank overdraft?(april2011) An overdraft occurs when money is withdrawn from a bank account and the available balance goes below zero. In this situation the account is said to be "overdrawn". 7. What is Profit- Volume ratio?(april2011) The P/v Ratio,which establishes the relationship between contribution and sales is of vital importance for studying the profitability of operations of a business.it reveals the effect on profit in the volume. Higher the P/V Ratio, more will be the profit and lower the P/V Ratio lesser will be the profit. 8. What is BEP? DEFINITION of 'Breakeven Point - BEP' 1. In general, the point at which gains equal losses. 2. in options, the market price that a stock must reach for option buyers to avoid a loss if they exercise. 9. What is cash forecast?(2011) Cash flow forecasting or cash flow management is a key aspect of financial management of a business, planning its future cash requirements to avoid a crisis of liquidity. 10. What is Leverage? (1) The degree to which an investor or business is utilizing borrowed money. (2) Companies that are highly leveraged may be at risk of bankruptcy if they are unable to make payments on their debt; 11. What do you understand by Business Finance? According to Guthmann & Dougall, business finance can be broadly defined as the activity concerned with planning, raising, controlling and administering of funds used in the business. MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 2 of 17

3 12. State the primary objective of financial management. To maximize the shareholders wealth. 13. State the decisions involved in financial management. a) Investment decision b) Financing decision c) Dividend decision. 14. What are the objectives of financial planning? i) To ensure availability of fund whenever required. ii) 15. What is private finance? To see that the firm does not raise funds unnecessarily. It is concerned with procuring money for private organization and management of the money by individuals, voluntary associations and corporations. 16. What is mean by public finance? Public finance is the study of the role of the government in the economy. It is the branch of economics which assesses the government and government expenditure of the public authorities and the adjustment of one or the other to achieve desirable effects and avoid undesirable ones. 17. Mention any two objective of financial management. i) Profit maximization ii) Wealth maximization 18. What is corporation finance? The term corporation finance includes, apart from the financial environment, the different strategies of financial planning. It include problems of public deposits, intercompany loans and investments, organized markets such as the stock exchange, the capital market, the money market and the bill market. 19. What are the aims of finance functions? Acquiring Sufficient and Suitable Funds. MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 3 of 17

4 Proper Utilization of Funds. Increasing Profitability. Maximizing Firm s Value. 20. What is risk return trade off? High risks are associated with the high potential returns and low risks are associated with low potential returns. Invested money can render high profit only if it is subject to the possibility of being lost. PART B QUESTIONS 1. What are the objectives of financial Management? (April2011-April/May2013) Effective procurement and efficient use of finance lead to proper utilization of the finance by the business concern. It is the essential part of the financial manager. Hence, the financial manager must determine the basic objectives of the financial management. Objectives of Financial Management may be broadly divided into two parts such as: 1. Profit maximization 2. Wealth maximization. Profit Maximization: Profit maximization is also the traditional and narrow approach, which aims at, maximizes the profit of the concern. Profit maximization consists of the following important features. The profit maximization objectives of the business concern: (i) Main aim is earning profit. (ii) Profit is the parameter of the business operation. (iii) Profit reduces risk of the business concern. (iv) Profit is the main source of finance. (v) Profitability meets the social needs also. Wealth Maximization: Wealth maximization is one of the modern approaches, which involves latest innovations and improvements in the field of the business concern. The term wealth means MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 4 of 17

5 shareholder wealth or the wealth of the persons those who are involved in the business concern. Favorable Arguments for Wealth Maximization (i) Wealth maximization is superior to the profit maximization because the main aim of the business concern. (ii) Wealth maximization considers the comparison of the value to cost associated with the business concern. (iii) Wealth maximization considers both time and risk of the business concern. (iv) Wealth maximization provides efficient allocation of resources. (v) It ensures the economic interest of the society. Unfavorable Arguments for Wealth Maximization (i) Wealth maximization leads to prescriptive idea of the business concern but it may not be suitable to present day business activities. (ii) Wealth maximization is nothing, it is also profit maximization, and it is the indirect name of the profit maximization. (iii) Wealth maximization creates ownership-management controversy. (iv) Management alone enjoys certain benefits. (v) The ultimate aim of the wealth maximization objectives is to maximize the profit. 2. What are different tools of financial analysis? (April/May2013) The analysis and interpretation of financial statements is used to determine the financial position. A number of tools or methods or devices are used to study the relationship between financial statements. Comparative financial statements Common size statements Trend analysis Ratio analysis Funds flow analysis Cash flow analysis Comparative financial statements: Comparative study of financial statements is the comparison of the financial statements of the business with the previous year s financial statements. It enables identification of weak points and applying corrective measures. MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 5 of 17

6 Common size statements: A statement where balance sheet items are expressed in the ratio of each asset to total assets and the ratio of each liability is expressed in the ratio of total liabilities is called common size balance sheet. Trend analysis: Trend analysis tries to predict a trend like a bull market run and ride that trend until data suggests a trend reversal (e.g. bull to bear market). Trend analysis is helpful because moving with trends, and not against them, will lead to profit for an investor. Ratio analysis: Ratio analysis is used to evaluate relationships among financial statement items. The ratios are used to identify trends over time for one company or to compare two or more companies at one point in time. Financial statement ratio analysis focuses on three key aspects of a business: liquidity, profitability, and solvency. Funds flow analysis: The net of all cash inflows and outflows in and out of various financial assets. Fund flow is usually measured on a monthly or quarterly basis. The performance of an asset or fund is not taken into account, only share redemptions (outflows) and share purchases(inflows). Cash flow analysis: Cash Flow is the movement of money into or out of a business, project, or financial product. It is usually measured during a specified, limited period of time. 3. What are the different methods used for analysis and interpretation of financial statements?(april2012) Financial statement analysis can be performed by employing a number of methods or techniques. The following are the important methods or techniques of financial statement analysis. MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 6 of 17

7 1. Ratio Analysis: Ratio analysis is the analysis of the interrelationship between two financial figures. 2. Cash Flow Analysis: Cash flow analysis is the analysis of the change in the cash position during a period. 3. Comparative Financial Statements: Comparative financial statement is an analysis of financial statements of the company for two years or of the two companies of similar types. 4. Trend Analysis: Trend analysis is the analysis of the trend of the financial ratios of the company over the years. The methods to be selected for the analysis depend upon the circumstances and the users' need. The user or the analyst should use appropriate methods to derive required information to fulfill their needs. 4. Why is the study of the relationship of cost-volume profit important to management?(april2012) Cost-volume-profit (CVP) analysis expands the use of information provided by breakeven analysis. A critical part of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs). At this breakeven point (BEP), a company will experience no income or loss. This BEP can be an initial examination that precedes more detailed CVP analyses. Cost-volume-profit analysis employs the same basic assumptions as in breakeven analysis. The assumptions underlying CVP analysis are: 1. The behavior of both costs and revenues in linear throughout the relevant range of activity. (This assumption precludes the concept of volume discounts on either purchased materials or sales.) 2. Costs can be classified accurately as either fixed or variable. 3. Changes in activity are the only factors that affect costs. 4. All units produced are sold (there is no ending finished goods inventory). MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 7 of 17

8 5. When a company sells more than one type of product, the sales mix (the ratio of each product to total sales) will remain constant. 5. What are the problems of financial planning?(april2011) Financial planning is a must for every finance department and for any enterprise that wants to be in financial control. Unfortunately it is a challenging exercise that is often inefficient and ineffective. Budgeting and planning exercises take analytical and people skills, experience, and the help of technology to make it effective. To be successful, those responsible for financial planning must have insight into cost and revenue drivers, and be able to link their initiatives to the overall corporate business strategy. In our experience, we have seen many issues related to failed financial planning initiatives. This blog post will highlight the top four offenders we commonly see our clients face. Data Data is king. Weak data management makes simple tasks such as accessing actual or forecast scenarios extremely difficult. There is no guarantee that once you reach your data it will be accurate, so focus on data is critical. Lack of Integrated Planning Tools Although sophisticated technology solutions exist for budgeting and planning, many organizations are still running on Excel. However, spreadsheets are an ineffective way to integrate inputs from many users. Multiple scenarios are hard to run due to limitations of managing data by spreadsheets. Planners spend their time trying to link spreadsheets together or diagnose issues that crop up within their spreadsheets. Inefficient Processes If you do decide to fix your financial planning process, it s important to decide exactly what you re trying to accomplish: Get planning closer to your business strategy? Work with business units and departments to introduce drivers? Accomplish better variance reporting and analytics? Produce corporate roll-up of plan and what-if scenarios? 6. Differentiate between share and debenture.(april2011) Ownership: The share of a company provides ownership to the shareholders. Debentureholders are creditors of a company who provide loan to the company. MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 8 of 17

9 Identity: Person holding share is known as shareholder. Person holding debenture is known as debenture-holder. Certainty of Return: No certainty of return in case of loss for the shareholder. Debenture-holder receives the interest even if there is no profit. Convertibility: Shares cannot be converted into debentures. Debentures can be converted into shares. Control: Shareholders have the right to participate and vote in company's meeting. Debenture holders do not possess any voting right and cannot participate in meeting. 7. Explain the following terms: (April2011) a) Break- even chart b) Margin of safety. Break- even chart: These are graphs which show how costs and revenues of a business change with a change in sales. They show the level of sales the business must make in order to break even. Criticism of break even analysis: Fixed cost is represented as a straight line but in actual fixed costs is likely to change at different levels of output. A stepped line may represent fixed cost more accurately. Important terms: Fixed cost: all costs which do not change with the change in output. Example rent, interest charges. Variable cost: All costs which change with the change in output. Example materials, fuel and labour cost. Total cost= fixed cost + variable cost MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 9 of 17

10 Revenue: income from sales of goods and services (Quantity sold X Price) Breakeven point is that level of output where the sales revenue is equal to the total cost. That level of output where there is no profit or loss. If a business is unable to reach this level of output it will suffer a loss from this product. Any output in excess of break even generates profit for the company. Margin of Safety: The horizontal distance between the breakeven level of output and the current level of output is known as margin of safety. MOS = MOS = Budgeted Sales Break-even Sales Budgeted Sales Break-even Sales Budgeted Sales Margin of Safety can be expressed both in terms of sales units and currency units. The margin of safety is a measure of risk. It represents the amount of drop in sales which a company can tolerate. Higher the margin of safety, the more the company can withstand fluctuations in sales. A drop in sales greater than margin of safety will cause net loss for the period. PART C QUESTIONS 1. Explain the relationship between financial management and other areas of management.(april2012) Financial management is one of the important parts of overall management, which is directly related with various functional departments like personnel, marketing and production. Financial management covers wide area with multidimensional approaches. 1. Financial Management and Economics: Economic concepts like micro and macroeconomics are directly applied with the financial management approaches. Investment decisions, micro and macro environmental factors are closely associated with the functions of financial manager. Financial management also uses the economic equations like money value discount factor, economic order quantity etc. Financial economics is one of the emerging area, which provides immense opportunities to finance, and MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 10 of 17

11 economical areas. 2. Financial Management and Accounting: Accounting records includes the financial information of the business concern. Hence, we can easily understand the relationship between the financial management and accounting. In the olden periods, both financial management and accounting are treated as a same discipline and then it has been merged as Management Accounting because this part is very much helpful to finance manager to take decisions. But nowaday s financial management and accounting discipline are separate and interrelated. 3. Financial Management or Mathematics Modern approaches of the financial management applied large number of mathematical and statistical tools and techniques. They are also called as econometrics. Economic order quantity, discount factor, time value of money, present value of money, cost of capital, capital structure theories, dividend theories, ratio analysis and working capital analysis are used as mathematical and statistical tools and techniques in the field of financial management. 4. Financial Management and Production Management: Production management is the operational part of the business concern, which helps to multiple the money into profit. Profit of the concern depends upon the production performance. Production performance needs finance, because production department requires raw material, machinery, wages, operating expenses etc. These e x p e n d i t u r e s are decided and estimated by the financial department and the finance manager allocates the appropriate finance to production department. The financial manager must be aware of the operational process and finance required for each process of production activities. 5. Financial Management and Marketing: Produced goods are sold in the market with innovative and modern approaches. For this, the marketing department needs finance to meet their requirements. The financial manager or finance department is responsible to allocate the adequate finance to the marketing department. Hence, marketing and financial management are interrelated and depends on each other. MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 11 of 17

12 6. Financial Management and Human Resource Financial management is also related with human resource department, which provides manpower to all the functional areas of the management. Financial manager should carefully evaluate the requirement of manpower to each department and allocate the finance to the human resource department as wages, salary, remuneration, commission, bonus, pension and other monetary benefits to the human resource department. Hence, financial management is directly related with human resource management. 2. Explain the various sources of long term finance.(april2011) Long-term sources of finance include: Equity Shares Preference Shares Debenture Long-term Loans Fixed Deposits Equity Shares: Equity Shares also known as ordinary shares, which means, other than preference shares. Equity shareholders are the real owners of the company. They have a control over the management of the company. Equity shareholders are eligible to get dividend if the company earns profit. Equity share capital cannot be redeemed during the lifetime of the company. The liability of the equity shareholders is the value of unpaid value of shares. Features of Equity Shares Equity shares consist of the following important features: 1. Maturity of the shares: Equity shares have permanent nature of capital, which has no maturity period. It cannot be redeemed during the lifetime of the company. 2. Residual claim on income: Equity shareholders have the right to get income left after paying fixed rate of dividend to preference shareholder. The earnings or the income available to the shareholders is equal to the profit after tax minus preference dividend. 3. Residual claims on assets: If the company wound up, the ordinary or equity shareholders have the right to get the claims on assets. These rights are only available to the equity shareholders. 4. Right to control: Equity shareholders are the real owners of the company. Hence, they have power to control the management of the company and they have power to take any decision regarding the business operation. 5. Voting rights: Equity shareholders have voting rights in the meeting of the company with the help of voting right power; they can change or remove any decision of the business concern MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 12 of 17

13 6. Pre-emptive right: Equity shareholder pre-emptive rights. The pre-emptive right is the legal right of the existing shareholders. 7. Limited liability: Equity shareholders are having only limited liability to the value of shares they have purchased. PREFERENCE SHARES The parts of corporate securities are called as preference shares. It is the shares, which have preferential right to get dividend and get back the initial investment at the time of winding up of the company. Preference shares may be classified into the following major types: 1. Cumulative preference shares: Cumulative preference shares have right to claim dividends for those years which have no profits. If the company is unable to earn profit in any one or more years, C.P. Shares are unable to get any dividend but they have right to get the comparative dividend for the previous years if the company earned profit. 2. Non-cumulative preference shares: Non-cumulative preference shares have no right to enjoy the above benefits. They are eligible to get only dividend if the company earns profit during the years. Otherwise, they cannot claim any dividend. 3. Redeemable preference shares: When, the preference shares have a fixed maturity period it becomes redeemable preference shares. It can be redeemable during the lifetime of the company. The Company Act has provided certain restrictions on the return of the redeemable preference shares. Irredeemable Preference Shares Irredeemable preference shares can be redeemed only when the company goes for liquidator. There is no fixed maturity period for such kind of preference shares. Participating Preference Shares Participating preference shareholders have right to participate extra profits after distributing the equity shareholders. Non-Participating Preference Shares Non-participating preference shareholders are not having any right to participate extra profits after distributing to the equity shareholders. Debentures: A Debenture is a document issued by the company. It is a certificate issued by the company under its seal acknowledging a debt. According to the Companies Act 1956, debenture includes debenture stock, bonds and any other securities of a company whether constituting a charge of the assets of the company or not. Types of Debentures Debentures may be divided into the following major types: MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 13 of 17

14 1. Unsecured debentures: Unsecured debentures are not given any security on assets of the company. It is also called simple or naked debentures.. 2. Secured debentures: Secured debentures are given security on assets of the company. It is also called as mortgaged debentures because these debentures are given against any mortgage of the assets of the company. 3. Redeemable debentures: These debentures are to be redeemed on the expiry of a certain period. The interest is paid periodically and the initial investment is returned after the fixed maturity period. 4. Irredeemable debentures: These kinds of debentures cannot be redeemable during the life time of the business concern. 5. Convertible debentures: Convertible debentures are the debentures whose holders have the option to get them converted wholly or partly into shares. These debentures are usually converted into equity shares. Conversion of the debentures may be: Non-convertible debentures Fully convertible debentures Partly convertible debentures 6. Other types: Debentures can also be classified into the following types. Some of the common types of the debentures are as follows: 1. Collateral Debenture 2. Guaranteed Debenture 3. First Debenture 4. Zero Coupon Bond 5. Zero Interest Bond/Debenture Retained Earnings: Retained earnings are another method of internal sources of finance. Actually is not a method of raising finance, but it is called as accumulation of profits by a company for its expansion and diversification activities 3. Explain the scope of financial management.(april2011) Financial management is one of the important parts of overall management, which is directly related with various functional departments like personnel, marketing and production. Financial management covers wide area with multidimensional approaches. The following are the important scope of financial management. 1. Financial Management and Economics. Economic concepts like micro and macroeconomics are directly applied with the financial management approaches. Investment decisions, micro and macro environmental factors are closely associated with the functions of financial manager. Financial management also uses the economic equations like money value discount factor, economic MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 14 of 17

15 order quantity etc. Financial economics is one of the emerging area, which provides immense opportunities to finance, and economical areas. 2. Financial Management and Accounting Accounting records includes the financial information of the business concern. Hence, we can easily understand the relationship between the financial management and accounting. In the olden periods, both financial management and accounting are treated as a same discipline and then it has been merged as Management Accounting because this part is very much helpful to finance manager to take decisions. But now a day s financial management and accounting discipline are separate and interrelated. 3. Financial Management or Mathematics Modern approaches of the financial management applied large number of mathematical and statistical tools and techniques. They are also called as econometrics. Economic order quantity, discount factor, time value of money, present value of money, cost of capital, capital structure theories, dividend theories, ratio analysis and working capital analysis are used as mathematical and statistical tools and techniques in the field of financial management. 4. Financial Management and Production Management Production management is the operational part of the business concern, which helps to multiple the money into profit. Profit of the concern depends upon the production performance. Production performance needs finance, because production department requires raw material, machinery, wages, operating expenses etc. These expenditures are decided and estimated by the financial department and the finance manager allocates the appropriate finance to production department. The financial manager must be aware of the operational process and finance required for each process of production activities. 5. Financial Management and Marketing Produced goods are sold in the market with innovative and modern approaches. For this, the marketing department needs finance to meet their requirements. The financial manager or finance department is responsible to allocate the adequate finance to the marketing department. Hence, marketing and financial management are interrelated and depends on each other. 6. Financial Management and Human Resource Financial management is also related with human resource department, which provides manpower to all the functional areas of the management. Financial manager should carefully evaluate the requirement of manpower to each department and allocate the finance to the human resource department as wages, salary, remuneration, commission, bonus, pension and other monetary benefits to the human resource department. Hence, financial management is directly related with human resource management. MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 15 of 17

16 4. Discuss of the function of financial management. A financial manager has to concentrate on the following areas of the finance function. Estimating Financial Requirements: The first task o f the financial m a n a g e r i s to estimate short term and long-term financial requirement of his business. For this purpose, he will prepare a financial plan for present as well as future. The amount required for purchasing fixed assets as well as the needs of funds for working capital has to be ascertained. The estimation should be based on the sound financial principles so that neither there are inadequate or excess funds with the concern. The inadequacy will affect the working of the concern and excess funds may tempt a management to indulge in extravagant spending. Deciding Capital Structure: The capital structure refers to the kind and proportion of the different securities for raising funds. After deciding about the quantum of funds required it should be decided which type of security should be raised. It may be wise to finance fixed securities through long term debts. Long-term funds should be employed to finance working capital also. Decision about various sources of funds should be linked to cost of raising funds. If cost of rising funds is high, then such sources may not be useful. A decision about the kind of the securities to be employed and the proportion in which these should be used is an important decision which influences the short term and the long term planning of the enterprise. Selecting a Source of Finance: After preparing a capital structure, an appropriate source of finance is selected. Various sources from which finance may be raised, includes share capital, debentures, financial deposits etc. If finance is needed for short periods then banks, public s deposits, financial institutions may be appropriate. If long-term finance is required the share capital, debentures may be useful. Selecting a Pattern of Investment: When fund have been procured then a decision about investment pattern is to be taken. The selection of investment pattern is related to the use of the funds. A decision has to be taken as to which assets are to be purchased? The fund will have to be spent first. Fixed asset and the appropriate portion will be retained for the working capital. The decision making techniques such as capital Budgeting, opportunity cost analysis may be applied in making decision about capital expenditures. While spending in various assets, the principles MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 16 of 17

17 of safety, profitability, and liquidity should not be ignored. Proper C a s h M a n a g e m e n t : Cash m a n a g e m e n t i s a n important task of financial manager. He has to assess the various cash needs at different times and then make arrangements for arranging cash. Cash may be required to make payments to creditors, purchasing raw material, meet wage bills, and meet day to day expenses. The sources of cash may be Cash sales, Collection of debts, Shortterm arrangement with the banks. The cash management should be such that neither there is shortage of it and nor it is idle. Any shortage of cash will damage the creditworthiness of the enterprise. The idle cash with the business mean that it is not properly used. Through Cash Flow Statement one is able to find out various sources and applications of cash. Implementing Financial Controls: An efficient system of financial management necessitates the use of various control devices. Financial control device generally used are; Return Investment Ratio analysis Break even analysis Cost control Cost and internal audit. The use of various control techniques: This will help the financial manager in evaluating the performance in various Areas and take corrective measures whenever needed. Proper use of Surpluses: The utilization of profits or surpluses as also an important factor in financial management. A judicious use of surpluses is essential for the expansion and diversification plans and also protecting the interest of the shareholders. The ploughing back of profit is the best policy of further financing. A balance should be struck in using the funds for paying dividends and retaining earnings for financing expansion plans MANAGEMENT/UNIT-1 Answers/VER 2.0 Unit 1 Answers Page 17 of 17

18 (UBA51) FINANCIAL MANAGEMENT Unit-2 (CURRENT ASSETS MANAGEMENT) Type: 100% Theory Question & Answers PART A QUESTIONS 1. What is inventory management?(april2012) Inventory management is a science primarily about specifying the shape and percentage of stocked goods. It is required at different locations within a facility or within many locations of a supply network to precede the regular and planned course of production and stock of materials. 2. What is management of Receivables? (April2012) Receivables, also termed as trade credit or debtors are component of current assets. When a firm sells its product in credit, account receivables are created. 3. Define Working capital.(april/may2013) The capital of a business which is used in its day-to-day trading operations, calculated as the current assets minus the current liabilities. 4. Define inventory.(april/may2013) Inventory is an asset that is owned by a business that has the express purpose of being sold to a customer. This includes items sold to end customers or distributors. It includes raw materials, work in process, and finished goods. 5. What is meant by the term money market?(april2011) Money market securities consist of negotiable certificates of deposit (CDs), bankers acceptances, U.S. Treasury bills, commercial paper, municipal notes, federal funds and repurchase agreements (repos). MANAGEMENT/UNIT-2 Answers/VER 2.0 Unit 2 Answers Page 1 of 14

19 6. What do you mean by Gross working capital?(april2011) Gross Working Capital: It refers to the firm s investment in total current or circulating assets. Working capital includes assets such as cash, checking and savings account balances, accounts receivable, short-term investments, inventory and marketable securities. Gross Working Capital is simply called as the total current assets of the concern. GWC= CA 7. Differentiate between fixed working capital and fluctuating working capital.(april2011) Fixed Working Capital. It is the capital; the business co ncern m u s t maintain certain amount of capital at minimum level at all times. Variable working capital. It is the amount of capital which is required to meet the Seasonal demands a n d some special purposes. 8. What is liquidity ratio? Liquidity ratios include the current ratio, the quick ratio and the operating cash flow ratio. 9. What is profitability? Profitability is the ability of a business to earn a profit. A profit is what is left of the revenue a business generates after it pays all expenses directly related to the generation of the revenue, such as producing a product, and other expenses related to the conduct of the business' activities. 10. What is net working capital? It is the excess of current assets over current liabilities. MANAGEMENT/UNIT-2 Answers/VER 2.0 Unit 2 Answers Page 2 of 14

20 PART B QUESTIONS 1. Explain the factors which should be kept in mind by a firm while determining policy for receivables.(april/may2013) 1.Sales Level Sales level is one of the important factors which determine the size of receivable of the firm. If the firm wants to increase the sales level, they have to liberalize their credit policy and terms and conditions. When the firms maintain more sales, there will be a possibility of large size of receivable. 2. Credit Policy Credit policy is the determination of credit standards and analysis. It may vary from firm to firm or even some times product to product in the same industry. Liberal credit policy leads to increase the sales volume and also increases the size of receivable. Stringent credit policy reduces the size of the receivable. 3. Credit Terms Credit terms specify the repayment terms required of credit receivables, depend upon the credit terms, size of the receivables may increase or decrease. Hence, credit term is one of the factors which affect the size of receivable. 4. Credit Period It is the time for which trade credit is extended to customer in the case of credit sales. Normally it is expressed in terms of Net days. 5. Cash Discount Cash discount is the incentive to the customers to make early payment of the due date. A special discount will be provided to the customer for his payment before the due date 6. Management of Receivable It is also one of the factors which affects the size of receivable in the firm. When the management involves systematic approaches to the receivable, the firm can reduce the size of receivable. MANAGEMENT/UNIT-2 Answers/VER 2.0 Unit 2 Answers Page 3 of 14

21 2. Explain the recommendations of chore committee on working capital finance. (April/May2013) Reserve bank of India appointed Chore Committee in April 1979, a working group under the chairmanship of Mr. K.B.Chore to look into this gap between the sanctioned limits and their utilization. The Chore Committee has, inter alia recommended as follows: Emphasized need for reducing the dependence of large and medium scale units of bank finance for working capital (1) To supplant to cash credit system by loans and bills wherever possible (2) To follow simplified information system but with penalties with such information is not forth coming within the specified limit. Chore Committee also suggested that the banks should adopts henceforth method II of the lending recommended by the Tondon Committee so as to enhance the borrowers contribution towards working capital. The observance of these guidelines will ensure a minimum current ratio of 1.33:1. Where the borrowers are not in a position to comply with this, excess borrowings on accounts of adoption of Method II should be segregated and converted into a Working Capital Term Loan (WCTL). This loan should be repayable in half yearly installments over a period not exceeding five years. WCTL may carry a rate of interest higher than the rate applicable on the relative cash credit, not exceeding the ceiling with a view to encourage an early liquidation of WCTL. It was also suggested that the banks suggested that the banks should fix separate limits where feasible peal level and non-peak level requirements with periods where there is a pronounced seasonal trend. It will not apply to agro-based industries but also to certain consumer approaching banks frequently for ad hoc limits in excess for the sanctioned limit excepting those special circumstances when such requests are considered for short duration with 1% additional interests over normal rate which could be waived in general cases of merits. Sick units may be allowed general exemptions from the above requirements. The committee also favored encouragement be given to bill finance i.e. bill acceptance and bill discounting practices involving banks, buyers and sellers. The Committee suggested some modifications and improvements in the system earlier recommended by the Tondon Committee. MANAGEMENT/UNIT-2 Answers/VER 2.0 Unit 2 Answers Page 4 of 14

22 The modified system includes that banks should submit half-yearly statements to RBI above credit limits of borrowers with aggregate working capital of Rs. 50 lakhs and above from the banking system. 3. Explain the objectives of inventory management.(april2011) Inventories occupy 30 80% of the total current assets of the business c o n c e r n. It is also very essential p a r t not only in the field of Financial Management but also it is closely associated with production management. Hence, in any working capital decision regarding the inventories, it will affect both financial and production function of the concern. Hence, efficient management of inventories is an essential part of any kind of manufacturing process concern. The major objectives of the inventory management are as follows: To efficient and smooth production process. To maintain optimum inventory to maximize the profitability. T o meet the seasonal demand of the products. T o avoid price increase i n future. T o ensure t h e level and site of inventories required. To plan when to purchase and where to purchase To avoid both over stock and under s t o c k of inventory. 4. Outline the recommendations of the Marathe committee.(april2011) Marathe committee observed that the borrower have to provide all the necessary and relevant information in time and in adequate detail. The long time taken in commercial banks in processing applications has to be reduced by suitable organizational changes. Improvements in the system as a whole have to be a conscious and continuous process in order to achieve the desired result. It suggested the followings. 1. The basis of bank lending should be changes from security based lending to funds flow based lending. 2. Credit needs are to be assessed and met by banks based on industry-wise working capital norms. 3. Deviations from these norms beyond the prescribed tolerance limits being seen as evidence of improper credit use by the borrower requiring prompt rectification. MANAGEMENT/UNIT-2 Answers/VER 2.0 Unit 2 Answers Page 5 of 14

23 4. Reliance of borrowers on bank finance for financing working capital should be progressively reduced by insistence on maintenance of a current ratio of 1.33:1 by a growing segment of borrowers, the minimum acceptable ratio being 1:1 5. Assessment of credit needs should be made on the basis detailed information to be provided by borrowers on past performance and future projections of working capital needs and overall performance. 5. Discuss the concepts of working capital.(april2011) Working capital can be classified or understood with the help of the following two important concepts. Gross Working Capital Gross Working Capital is the general concept which determines the working capital concept. Thus, the gross working capital is the capital invested in total current assets of the business concern. Gross Working Capital is simply called as the total current assets of the concern. Net Working Capital GWC =CA Net Working Capital is the specific concept, which, considers both current assets and current liability of the concern. Net Working Capital is the excess of current assets over the current liability of the concern during a particular period. If the current assets exceed the current liabilities i t is said to be positive working capital; it is reverse, it is said to be Negative working capital. NWC = C A CL 6. How do treasury bills constitute an important segment of the money market?(april2012) 1. Certificates of Deposit (CD): It is a document issued by a bank acknowledging a deposit of money with it and constituting a promise to repay that sum to bearer at a specified future date. CDs are negotiable. MANAGEMENT/UNIT-2 Answers/VER 2.0 Unit 2 Answers Page 6 of 14

24 2. Treasury Bills: It is a short-term borrowing medium of the UK Government introduced in 1877 and was modelled on the commercial bill. Treasury Bills have a term of 91 days; 63 day bills are issued at CERTAIN terms of the year, and they are sold by tender in weekly lots with the Tap issue to the government departments and other public agencies, The Treasury Bills remain an important financial instrument with a significant role in the operation of monetary management. 3. Treasury Deposit Receipts (TDR): The TDR is a short-term six month, non-marketable security introduced by the UK government in 1940 as an instrument of war time finance and sold in determined weekly amounts to the banks. These securities were in effect form of compulsory borrowing from the banking system and by 1945 formed almost 40 percent of the assets of the London clearing banks. Thereafter, their issue was progressively reduced and they were phased out in Commercial Bills: This is yet another money market instrument. It is a short-term debt instrument in the form of a document ordering a drawee (i.e., the debtor) to pay the drawer (the creditor) a stated sum at a specified date or at sight. Once accepted i.e., signed either by the drawee who may be an Accepting House or bank, and endorsed by the acceptor, a bill becomes negotiable and may be discounted at a rate which reflects the current rate of interest. 5. Treasury Bills:These are claims against the government; they are negotiable and since they can be rediscounted with the bank, they are highly liquid. The other features are absence of default risk easy availability, assured yield, low transaction cost, eligibility for inclusion for Statutory Liquidity Ratios (SLR) purposes and negligible capital depreciation as Treasury Bills are 14 days, 91 days, 182 days, days, maturity. 7. Explain : (April2012) i. Profitability Ratios ii. Liquidity Ratios. MANAGEMENT/UNIT-2 Answers/VER 2.0 Unit 2 Answers Page 7 of 14

25 Profitability Ratios: Profitability ratio is a measure of profitability, which is a way to measure a company's performance. Profitability is simply the capacity to make a profit, and a profit is what is left over from income earned after you have deducted all costs and expenses related to earning the income. Types of Profitability Ratios: Common profitability ratios used in analyzing a company's performance include i) Gross profit margin (GPM), ii) Operating margin (OM), iii) Return on assets (ROA), iv) Return on equity (ROE), v) Return on sales (ROS) and Return on investment (ROI). Liquidity Ratios: Liquidity ratios are the ratios that measure the ability of a company to meet its short term debt obligations. The liquidity ratios are a result of dividing cash and other liquid assets by the short term borrowings and current liabilities. Acid-Test Ratio Cash Ratio Current Ratio Net Working Capital Quick Ratio Working Capital Working Capital Ratio MANAGEMENT/UNIT-2 Answers/VER 2.0 Unit 2 Answers Page 8 of 14

26 PART C QUESTIONS 1. Explain the different features of money market securities.(april2011) The purpose of money markets is facilitate the transfer of short-term funds from agents with excess funds (corporations, financial institutions, individuals, government) to those market participants who lack funds for short-term needs. They play central role in the country s financial system, by influencing it through the country s monetary authority. For financial institutions and to some extent to other nonfinancial companies money markets allow for executing such functions as: Fund raising; Cash management; Risk management; Speculation or position financing; Signaling; Providing access to information on prices Money market segments: Money market consists of the market for short-term funds, usually with maturity up to one year. It can be divided into several major segments: Interbank market, where banks and non-deposit financial institutions settle contracts with each other and with central bank, involving temporary liquidity surpluses and deficits. Primary market, which is absorbing the issues and enabling borrowers to raise new funds. Secondary market for different short-term securities, which redistributes the ownership, ensures liquidity, and as a result, increases the supply of lending and reduces its price. Derivatives market market for financial contracts whose values are derived from the underlying money market instruments. The money-market instruments are often grouped in the following way: Treasury bills and other short-term government securities (up to one year); Interbank loans, deposits and other bank liabilities; Repurchase agreements and similar collateralized short-term loans; Commercial papers, issued by non-deposit entities (non-finance companies, finance companies, local government, etc. ; MANAGEMENT/UNIT-2 Answers/VER 2.0 Unit 2 Answers Page 9 of 14

27 Certificates of deposit; Eurocurrency instruments; Interest rate and currency derivative instruments. Major characteristics of money market instruments are: Short-term nature; low risk; high liquidity (in general); close to money. Money markets consist of tradable instruments as well as non-tradable instruments. Traditional money markets instruments, which included mostly dealing of market participants with central bank, have decreased their importance during the recent period. Economic significance of money markets is predetermined by its size, level of development of infrastructure, efficiency. Growth of government securities issues, their costs considerations, favourable taxation policies have become additional factors boosting some of the country s money markets. 2. Explain how the working capital needs are assessed.(april/may2013-april2011) Every business needs some amount of working capital. The need for working capital arises due to the time gap between the production and realization of cash from sales. Thus working capital is needed for the following purposes: a. For the purchase of raw material, components and spares parts. b. To pay wages and salaries c. To incur day-to-day expenses. d. To meet the selling costs s packing, advertising. e. To provide the credit facilities to the customers. f. To maintain the inventories of Raw material, work in progress, finished stock There is an operating cycle involved in the sales and realization of cash. The cycle starts with the purchase of raw material and ends with the realization of cash from sales of finished foods. It involves purchase of raw material and stores, it conversion in to stock of finished goods through work-in- progress, conversion of finished stock in to sales, MANAGEMENT/UNIT-2 Answers/VER 2.0 Unit 2 Answers Page 10 of 14