By CA.

Bhupesh Anand

CHAPTER-1
Nature, significance & scope of financial MANAGEMENT

Q1.What is the Meaning of Financial Management ?

Q2 Explain two functions of Financial Management?[CS JUNE 2011]{100 times approx
A: At any movement of time, a business firm can be viewed as a pool of funds coming
from various sources i.e. equity shares, preference shares, debentures, financial institutions and
post earning retained in the business. Funds raised from the sources are committed to a number of
uses i.e. fixed assets used in production of goods and services, inventories used to facilitate
production and sales, accounts receivable owed by customers and cash and marketable securities
used for transactions and liquidity purposes. At a given moment, the pool of funds of the firm is
static overtime, however, the pool changes; throughout the enterprise.
and these changes are known as funds flow. In an on going business funds flow continually The term
finance can be defined as the management of flow of funds through on organisation or procurement
of funds (in flows) and their effective utilisation (out flows).Financial Management is a specialized
functional field dealing with the management of finance right from estimation and procurement till
its effective utilisation in the business. It is an area looked after by the finance manager who
deals with the following issues:
(i) Which new proposals for employing capital should be accepted by the firm?
(ii) How much working capital will be needed to support the firm’s operations?
(iii) Where should the firm go to raise long term capital and how much will it cost?
(iv) Should the firm declare dividends on its equity capital and, if so, how large a
should be declared?
(v) What steps can be taken to increase the value of firm’s equity capital?
The above issued are solved by taking three major decision (i) Investment decision (ii)Financing
decision and (iii) Dividend decision. As objective of the Financial Management is tomaximise the
value (i.e. wealth of shareholders), the firm should strive for an optimal combination of the three
interrelated decision, solved jointly.
The decision to invest in a new capital project, for example, necessitates financing the investment.
The financing decision, in turn, influences, and is influenced by, the dividend
decision. The retain- ed earnings used in internal financing represent dividends foregone by the
shareholders. With a proper conceptual framework, joint decisions that tend to be optimal canbe
reached.

There is Never A wrong Time to Do The

Right Thing

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FINANCE + MGT.

OBJ of F.M.

MEANING OF F.M.
Maximisation of Share
Holder’s Wealth Effective & efficient Utilisation of
financial resources

Three Questions ?

Q.1 : What is the requirement of finance ?

Q.2 : How the finance can be procured ?

Q.3 : Where to utilise it ?

1
DECISION 1 DECISION 2 2 DECISION 3 3

Investment Financial Dividend

Decisions Decision Decision

Q.3Q.What are the Main Functions of Financial Management ?

Q.4Q.Discuss the functions of a chief financial officer :
Q.5Q.What are the main responsibilities of a chief financial officer of an
organisation? [CS Dec.2014] [(V.Imp Q]
A: Procurement of funds and effective utilisation of funds are the most important functions of
a financial manager Besides, a financial manager has to look into financial viability of all the
decisions in the organisation, he ensures that different considerations like risk and costs are
properly balanced in decision making.
Sometimes duties of a manager are compared with duties of on accountant. An accountant
has to basically record the information for use in preparation of balance sheet and profit
and loss account. The job of a finance manager is entirely different from that of an
accountant. He has to manage funds. This involves a lot of decision-making. someone of the
functions of a finance e manager are summarized below : below:

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Estimating the fund requirements: A finance manager has to make estimates of both long-term
and short term requirements of funds. It requires systematic projection of expected actions of
management in the form of financial conditions in the industry as well as in the firm. This function
culminates in the preparation of projected income statement and projected balance sheet.

(ii) Capital structuring: After the requirements of funds have been estimated, the financial
manager has to decide the proportions of equity and debt in the capital structure of an enterprise.
This means deciding what financial leverage a firm should have. A proper mix of the various sources
has to be worked out. The finance manager has to maintain a proper balance between long-term
funds and

iii) Raising of funds: Traditionally, the scope of financial management was limited simply to
raising of funds. It still remains only one of the functions of financial management. He is to
see that all the formalities for making the issue are complied with in accordance with law of
loan.

(iv) Allocation of funds: procured from different sources have to be invested in various kinds of
assets. Long term funds are used in a project for various fixed assets and also for current
assets. The investment of funds in a project has to be made after careful assessment of the
various projects through capital budgeting. Financial manager is vitally concerned about
efficient allocation of funds to competing projects.

(v) Profit Planning: The scope of financial manager’s functions has been broadened to include
profit planning function. By involving in profit planning, a finance manager plays an important
role in almost all operating decisions in the areas of pricing, cost, volume of output and
firm’s selection of product lines. Profit planning is essential for optimising investment and
financial decisions. In this decision-making area, a financial manager contributes substantially
by analysing risk related to different projects.

(vi) Understanding Capital Markets : A financial manager is expected to have sound knowledge
ofcapital market, where firm’s securities are traded. He should know how risk is measured in
capital markets and how to cope with it as investment and financing decisions often involve
considerable risk.

(vii) Measuring requited return : The acceptance of an investment proposal depends on whether
the expected return from the proposed investment is equal to or more than the required
return. The expected return from the proposed investment is equal to or more than the
required return. The determination of required rate of return is the responsibility of
financial manager and is a part of financing decisions.

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(viii) Dividend decision : The finance manager is also concerned with the decision to pay or
declare a dividend. He has to assist the top management in deciding as to what amount of
dividend should be paid to the shareholders and what amount should be retained in the
business itself.
This involves a large number of considerations namely: whether the company or the
shareholders can make a more profitable use of the funds, trend of earnings, the trend of
share market prices,the requirement of funds for future growth, the cash flow situation, th
tax position of shareholders, etc.,are to be kept in mind.

(ix) Cash management : The finance manager has also to ensure that all sections i.e.,
branches,factories, departments and units of the organisation are supplied with adequate
funds. Sections which have on excess of funds have to contribute to the central pool for use
in other sections which need funds. An adequate supply of cash at all points of time is
absolutely essential for the smooth flow of business operations.

(x) Evaluating financial performance: Management control systems are often based upon
financial analysis. One prominent example is the ROI (returns on investment) System of
divisional control. A finance manager has to constantly review the financial performance of
the various units of the organisation. Analysis of the financial performance helps the
management for assessing how the funds have been utilized in various divisions and what can
be done to improve it.

(xi) Financial negotiations: A major portion of the time of the finance manager is utilised in
carrying out negotiations with the financial institutions, banks, and public depositors. He has
to furnish a lot of information to these institutions and persons and has to ensure that
raising of funds is within the statutes like Companies Act, etc. Negotiations for outside
financing often required specialised skills.
(xii) Credit Management:
(a) Determination of Customer’s credit risk.
(b) Orderly handling of collection.
(c) Handing cash discounts and terms of Sale for prompt payment.

¨ Financial decisions are crucial-for the survival of the firm. The growth and development of
the firm depends upon the financial policies and strategies. Further the financial decisions
determine solvency of the firm. At no cost a firm can afford to threaten its solvency.
Solvency of a firm depends upon the flow of funds in an organisation which is a result of
various financing decisions.

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¨

The finance function occupies such a major place in the organisation that it cannot be the
sole responsibility of are executive.

¨ The important aspects of the finance function have to be carried on by the Top Management,
i.e., the Managing Director and the Board of Directors. It is the Board of Directors which
makes the final decisions involving finance.

¨ The variety of designations are used for financial managers. There is no complete unanimity
on this, some firms designate as Financial Controller, Vice-President (Finance), Chief
Accountant and Treasurer. He is responsible for all financial activities. Two more financial
officers may be appointed under his direct supervision who assist him.

¨ The Financial Controller is basically meant for assisting the top management. He has the
important role-of contributing to good decision making on issues which involve all the
functional areas of thebusiness. He must clearly bring out financial implications of the
enterprise.

ORGANISATION CHART OF FINANCE FUNCTION:

(i) The Chief finance executive (his designation may vary from company to company) works
directly under the President or the Managing Director of the company.

(2) Besides routine work, he keeps the Board of Directors informed about all the phases of
business
Activity, including economic, social and political developments affecting the business
behavior.

(3) He also furnishes information about the financial status of the company by reviewing it from
time to time. The chief finance executive may have many officers under him to carry out his
functions channels.

(4) Broadly, his functions are divided into two: (i) Treasury functions and (ii) Control functions.
Organisation Chart of Finance Function

Q.6.6 What are Different Financial Tools ?

[CS/CWA DEC.2012]

A: Financial tools are the techniques that can be employed by the finance manager to solve the
problem properly, effectively and efficiently. The following are the financial tools:
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(i) Ratio analysis (vii) Ageing schedule

(ii) Fund flow and cash flow analysis (viii) Projected financial statements
(iii) Cash budget (ix) Cost of capital

(iv) ABC analysis (x) Leverages

(v) EOQ model (xi) Hedging
(vi) Long-term investment appraisal tools-pay back period net present value,
profitability index, internal rate of return, etc.

Q.7 Whether Investment, Financing and Dividend Decisions are all Inter-related ?
[CA Final NOV 2011] [CS DEC 2012]
A: Investment Decisions :These involve the allocation of resources among various type of
assets.
What portion of the firm’s fund should be invested in various current assets such as cash,
market-able securities and receivable and what portion in fixed assets, such as inventories
and plant and equipment The assets mix affects the amount of income the firm can earn.
For example, a manufacturer is in business to earn income with fixed assets such as
machinery and not with current assets. However, placing too high a percentage of its assets
in new building or new machinery may leave the firm short of cash to meet an unexpected
need or exploit sudden opportunity. The firm’s financial manager must invest in fixed assets,
but not too much. Besides determining the assets mix, financial manager must also decide
what type of fixed and current assets to acquire. All this covers area pertaining to capital
budgeting and working capital management.

¨ Financing Decision : It is the next step in financial management for executing the
investment decisions once taken. A look at the balance-sheet of a company indicates that it
obtains finance from shareholders ordinary, preference, debenture holders, or long-term
loans from the institutions, banks and other sources. There are variations in the provisions
contained in preference shares, debentures, loans papers etc.
Thus financing decisions are concerned with the determination of how much to obtain from
one source and how much from other or others i.e. the financing mix of capital structure.
Efforts are made to obtain an optimal financing mix for a particular company. This
necessitates study of capital structure as also the short and intermediate term financing
plans of the company.

In more advanced companies financing decision today, has become fully-integrated with top-
management policy formulation via capital budgeting, long-range planning, evaluation of
alternate uses of funds, and establishment of measurable standards of performance in
financial terms.

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¨ Dividend Decisions : The third major decision of financial management is the decision
relating to the dividend policy. The dividend decision should be analysed in relation to the
financing decision of a firm. Two alternatives are available in dealing with the profits of a

firm ; they can be retained in the business. Which courses should be followed - dividend or
retention? One significant element in the dividend decision is therefore the dividend pay out
ratio, i.e. what proportion of net profits should be paid out to the shareholders. The decision
will depend upon the preference of the shareholders and investment opportunities available
within the firm. The second major aspect of the dividend decision is the factors
determining dividend policy of a firm in practice.

All the above decisions of finance are inter-related with one another. Any decision
undertaken by the firm in one area has its impact on other areas as well.

For example acceptance of an investment proposal by a firm affects its capital structure and
dividend decision as well. So these decisions are inter-related and should be taken jointly so
that financial decision is optimal. All the financial decisions have ultimately to achieve the
firm’s goal of maximisation of shareholders wealth.

Q.8 Whether Financial Management as a Science or as an Art ? [CWA 10 TIMES]

[CS JUNE 2013]
A: Financial Management is science or an art is a debatable issue. In true sense, neither it is
pure science like physics, nor it is an art like painting.
It lies somewhere between two extremes. It is science because it is based on theoretical
prepositions and procedures adopted in the business enterprises.
The subject matter of the financial management in addition to theoretical propositions
includes the body of rules and regulations. It also takes the help of statistical techniques,
econometric models, operational research and computer technology for solving corporate
financial problems.
These problems may be relating to budgeting decisions, choice of investment acquisition or
allocation of funds, locating sources of capital and various other areas. In this way the
nature of financial management is nearer to the applied science as it envisages the use of
classified and tested knowledge in solving business problems.

Despite the use of scientific methods in the area of financial management, there remains a
wide application of value judgement in financial decision – making. Application of
mathematical or
computer based packages provide in many cases no solutions unless human thinking and skills
are applied for making choice. Thus the application of human judgement skills become
necessary. In many cases, such judgement is based on experience of a particular finance
manager making the

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decisions. The application of human judgement in the decision making makes financial
management an art along with its features of science. Thus, in this way knowledge of facts,
principles and concepts as well as personal involvement of finance manager along with

application of skills in the analysis and decision-making process makes the financial
management both science as well as art.

Q. 9 What are Objectives of Financial Management ?

Q.10 Explain conflicts in profit versus wealth maximisation principle:-
Q.11 Explain the limitations of profit maximisation objective of Financial
Management ? (CWA 50 times)(CS 5 Times)
A: Following are the two widely discussed objectives of financial management:
(i) Profit Maximisation: Based on this objective, the investment, financing and dividend policy
decisions of a firm should be oriented to the maximisation of profit. The term profit can be
used in two ways- as on owner-oriented concept, i.e., the amount which is paid to the owners
of business, i.e., hose who supply equity capital, a variant of the term is profitability. It is
operational concept and signifies economic efficiency. In other words, profitability refers to
a situation, where output exceeds input, i.e., the value created by the use of resources is
more than the total of input resources. Based on this criterion, a firm should be guided in
financial decision-making by one test, i.e., select assets, projects and decisions which are
profitable and reject those, which are not. The rationale behind this objective is simple.
Profit is test of economic efficiency. This objective leads to efficient allocation of
resources, as resources tend to be directed to uses which in terms of profitability are most
desirable. It is also stated that this objective leads to social welfare in that goods and
services desired by soc- iety are produced in the greatest quantity possible given the
available stock of productive resources. But the profit maximisation as on objective
suffers from following Shortcomings:
(a) Ambiguity: Profit figure will widely vary depending upon accounting interpretations. Some
hold the view that profit is a vague and ambiguous concept. It does not have precise
connotation.It conveys different meanings to different people. To illustrate, profit may be
short term or long-term. It may be profit before tax or after tax. It may be return on
capital employed or total assets or shareholders’ equity and so on.
(b) Timing of benefits: Another shortcoming of profit maximisation criterion is that it does not
flows over times. For decision-making purposes it is essential to recognise that money has a
time value. But, the profit-maximisation objective does not take into account differences in
timing of cash flows and thus time value of money.
(c) Ignores uncertainty: Another limitation of profit maximization objective is that it does not
take care of uncertainty. As a general rule, the more certain is the expected return, the
higher will be the quality of benefits. An uncertain and fluctuating return implies risk to
investors.The problem of uncertainty renders profit-maximisation objective unsuitable as on
operational criterion for financial manage ment, as it considers only the size of benefits
and gives no weightage to the degree of uncertainty of future benefits.

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To summarise, the profit-maximisation criterion is an inappropriate objective of financial
management, because it ignores two important dimensions i.e., risk and time value of money.

(ii)
Wealth (or value) maximisation: Value (or wealth) maximisation means the maximisation of
the net present value of a course of action. The net present value of a course of action is
the difference between the present value of its benefits (i.e., stream of future expected
cash flows) and thus of its cost. The stream of future cost flows and the related cost of the
course of action are discounted at a rate that reflects both time and uncertainty.

If a single alternative is being considered, then it should be considered as if it has a positive

net pr- present value. If mutually inclusive profits are under consideration, then the
alternative, that shows the highest net present value should be accepted.
This approach assumes that the objective of financial management is to maximise the value
of the firm.
The reasons in favour of wealth maximisation objective are listed below:
(a) Measuring benefits in terms of cash flows avoids ambiguity associated with accounting
profit.
(b) This objective considers both the quantity are quality dimensions of benefits. At the
same time, it incorporates the concept of time value of money.
From the above it clear that net present value maximisation is superior to profit
maximisation as on objective of financial management. It should also be kept in mind that
where the time period is short and degree of uncertainty is not great, value maximisation
and profit maximisation account for essentially the same things.

Stockholders hire managers to run their for them………

Because Stockholders have absolute power to hire and fine managers………..

Managers set aside their interest and maximum stock prices………

Because markets are efficient……..

Stockholders wealth is maximised……

Because lenders are fully protected from shareholders action……..

Firm value is maximised

Because there are no costs created for society…….

Societal wealth is maximized

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Q.12 What are the differences between Accounting and Finance ? [*** Star Q]
A:
Accounting Finance

i) Accounting is a systematic way of recording i)The term finance can be defined as the classifying,
summarising and preparing final managemtof flow of funds through an
accounts and measuring of business transa- organisation procurement of funds
ctions.(in flows) and their effective utilisation (out flows).

ii) Using a widely accepted double entry, ii)Finance makes use of the information provided
book-keeping system, accounting provides the accounting system to make decisions

data on an organisation’s activities. respect to inflows and out flows,

which help
organisations in achieving objectives.

iii) Accounting is a data collection process iii) Finance is a management or decision

dealing the accurate recording and reporting. making process.

Q.13 Whether It is advantageous to decentralise accounting function while finance

function should be centralized”.
( CS /CWA )
It is well known that Accounting is related to recording and keeping information regtransact-
ions of business. Management Accounting, a branch of accounting is involved in analysing and
pr- providing of timely information for planning, control and managerial decision making. With
decent ralized set up in various organizations, the role of management accountants as a part
of decision ma-king process has become the order of the day. Decentralisation reduces the
time involved in provi- ding information and enables the accountants to tackle the situation in
a better way and become part of the organisation. The other functions of management such
as production etc., are also able to appreciate the facts better in a decentralised set up.
Hence, it is better to decentralise accounts foroperational convenience and better control.

The finance function is mainly concerned with procurement and utilisation of funds. This
involves more of interaction with top management. This area has become more specialised
both in terms of Legal requirement and cost effectiveness. The finance function involves
more of outside relationship with Bankers, Financial institutions and a lot of others. As the
nature of function has become speci-alised and outside relationship oriented it is better to
centralise finance function. The following points more elaborately focus as to whether
finance function should be centralised or decentralised.
(i) Accounting and finance are two separate functions though there is considerable overlapping
between the two. Accounting is primarily concerned with recording and presentation of

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information peri dically wherea finance deals with procurement and utilisation of funds and
with supply of funds to all sections of the enterprise.

(ii)

The question of centralisation or de-centralisation of the accounting and finance functions in

a company is therefore to be examined separately. It is quite possible that in one company
finance is cent- ralised whereas accounting is de-centralised. It is also possible that in
another company both finance and accounting are totally centralised or wholly de-centralised.

(iii) A prime consideration in centralising or de-centralising the accounting and finance functions
is the basic management philosophy. Management which believe in high centralisation would
certainly like that financeand accounting are centralised. On the other hand, companies
working on the principles or de-centralisation often have their various plants organised on an
independent basis with the divi-sional manager having vast powers of decision making,
planning and control at the plant level itself. Obviously, in such case, the accounting function
is certainly required to be de-centralised whereas the finance function has to be partly de-
centralised.

(iv) Another criterion in deciding whether the accounting and finance functions should be
centralised or de-centralised is the capability of the firm to process information quickly.

Q.14 Explain Profitability may not always assure liquidity ?

(CS,CWA 5Times) (London Dreams TYPE OF Q)

A: Profitability is the ratio of profit per rupee of sales / investment. It reflects the firm’s
ability to generate profits per unit of sales. If sales lack sufficient margin of profit, it is
difficult for the business enterprise to cover its fixed costs, including fixed charges on debt
and to earn profit for shareholder.The net profit margin indicates the firm’s ability to
generate profits after paying all taxes and expenses. The ratio reflects the ability of the
firm to utilise its assets effectively.

Profitability thus is a measure of efficiency and the search for provides an incentive to
achieve efficiency. It also indicates public acceptance of the firm’s product and shows that
the firm can produce competitively. In addition it is profits which generate resources for
repaying debts incurred to finance project and for internal financing of expansion.

Liquidity on the other hand may be defined as the firm’s ability to meet its short term and
obligations on their becoming due for payment. It reflects the firm’s ability to convert its
assets into cash to pay its dues on schedule, and is a perquisite for the very survival of a

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firm. Liquidity is assessed through the use of ratio analysis. These ratios help to analyse the
present cash solvency of a firm and its ability to remain solvent in the event of unexpected
occurrence.

While short term creditors of the firm as interested in the short term solvency or liquidity
of a firm, liquidity implies from the point of utilisation of the funds of the firm, that funds
are idle or they earn very little.

The three motives which affect the management’s attitude towards liquidity are (I)
Transaction motive ; the firm must maintain adequate case to meet its short term liabilities
covering a period of upto one year (ii) Precautionary motive. idle cash must be maintained
to meet unexpected demands for funds due to occurrence of unforeseen circumstances ; and
(iii) Speculative motive ; the manage- ment may like to maintain adequate funds to take
advantage of an unexpected bargain / deal when may come its way in the near future.

While both liquidity and profitability are crucial for efficient financial management of a
firm, these are basically contradictory financial decisions. Decision taken by the finance
manager to increase profitability generally strain the liquidity position of a firm.
For example a firm may opt for debt financing vis-à-vis equity financing due to the in built
tax (leverage) advantage. The decision however is likely to strain the liquidity position of the
firm, due to the periodic interest and re –payment obligations. Equity financing however
places no such obligation on the firm, and the decision to pay dividends is discretionary.
With increase in debt component in the capital structure of a firm, the expected
profitability goes up. Although endangering liquidity in the process. The financial manager’s
job therefore entia ils maintaining a balance between liquidity and profitability. While
maximising returns he must ensure maintenance of safe liquidity position for the firm.

Q.15 How Depreciation is a source of finance ? [EK THA TIGER TYPE Q]

A: Depreciation is a non-cash expenditure. Companies are entitled to charge depreciation to

profit and loss account while computing their profits. The basic idea to permit a
company to charge the depreciation as an expense is to enable the company to conserve
resources for replacement of fixed assets. However, in actual practice depreciation funds
are not accumulated and do not become the source of finance for future capital expenditure.
They remain in the business and generally utilised for working capital purposes. During
recent years, big controversy has developed among academiccian and executive about
depreciation as a source of finance for the purposes of modernisation and expansion of
industrial enterprise. From purely an accounting point of view, depreciation is the recovery
of the cost of a fixed assets out of current operations. It is an expense, a non-cash

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expenses, chargeable to current operations to recover a part of the cost of the fixed asset.
The accountant does not agrees with the statement that depreciation generates funds. It is
operations that generate funds and depreciation is merely an expenses entered in the books
to recover the original cost (as against replacement cost) of a fixed assets from its useful
life- determined by adopting the procedure laid down by tax authorities.

For the finance manager, depreciation is the best single source of internal funds for
financing gross capital formation in business. Modernisation and expansion of the industrial
enterprise in the last two decades has been financed to a substantial and still rising extent
by these mounting depreciation charges.

There should not, however, be any conflict between these two points of view. Depreciation
does notinitiate a flow of funds into the firm. Revenue realised from sales is the source of
funds and depreciation charges serve to keep the operations of the revenues inside the firm
in the sense that they constitute a non-cash expense. What happens to this non-cash
expense depends upon the growth rate other firm and upon its financial policy.

Q.16 Whether ‘The information age has given a fresh perspective on the role of
finance management and finance managers. (CS June 2011) (CWA Exams)

A: With the shift in paradigm it is imperative that the role of Chief Financial Officer (CFO)
changes from a controller to a facilitator.” The information age has given a fresh perspective
on the role of financial management and finance managers. With the shift in paradigm it is
imperative that the role of Chief Finance Officer (CFO) changes from a controller to a
facilitator.
In the emergent role Chief Finance Officer act as a catalyst to facilitate changes in an
environment where the organisation succeeds through self managed teams. The Chief
Finance officer must transform himself to a front end organiser and leader who spends
more time in networking, analyzing the external environment, making strategic decisions,
managing and protecting cash flows. In due course, the role of Chief Finance Officer will
shift from an operational to a strategic level. Of course on an operational level the Chief
Finance Officer cannot be excused from his back end duties.
The knowledge requirements for the evolution of a Chief Finance Officer will extend from
being aware about capital productivity and cost of capital to human resources initiatives and
competitive environment analysis. He has to develop general managements skills for a wider
focus encompassing all
aspects of business that depend on a dictate finance.

Q.17 Discuss the Relationship of Globalization, Liberalisation & Financial Management

?
[CS JUNE 2013] [CA MAY 2016]

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A: Globalisation means integration of national economy to the world economy. In economic
sense, globalisation refers to borderless world where there is free flow of money and
currencies, ideas and expertise, postering partnership and alliance to serve the customers
best.Financial decision making deals with financial matter of a corporate enterprise i.e. kind
of assets to

be acquired, pattern of capital structure and distribution of corporate income etc. in order
to maximise the shareholders wealth in the organisation. Globalisation integrates national

financial market and thus creates new financial environment which brings new opportunities
and challenges and influences the financial decision (investment decision, financing decisions
and dividend decisions) making in the organisation in following way :

Complicates the task of investment decisions: Presently the investment decision making
has become a complicated and tedious exercise. Corporate units now along with national
conditions also takes into account global view i.e. foreign exchange risk exposure, economic,
political, legal and tax parameters while making investment decisions. It demands higher
level of expertise from finance executives to understand the situation and to arrive at
optimal investment decisions.

Widens the scope raising the funds: Corporate units now have access to foreign market to
raise the resources at competitive rates. Foreign institutional investors and NRI may also
participate in this process and this help in attaining the least cost capital structure.
Dividend decision have to be taken in the light of global scenario and available portfolio
opportunies, and internal needs of the corporate units.
Liberalisation is a process which is aimed at to create an atmosphere of free competition
among different agents of production and distribution of goods and services, finance and
trade both public and private, domestic and foreign, small and large alike. The major
components of liberalisation process includes changes in industrial policy which amounted to
radical transformation of the entire industrial environment. The major impact of
liberalisation on the Indian industry include the following :
Optimum utilisation of financial, material and human resources ;
Effective role of market mechanism in determination of allocation of resources ;
Boost in trade and commerce ;
 Encouragement to foreign investment and integration of country’s economy with global economy ;
 Increase in number of foreign collaborations and transfer of technologies ;
 Capital inflows and improvement in foreign reserve position ;
 Development of infrastructure.

Q.18 Financial policy and corporate strategy are most significant concerns of top
management.explain?
[CS DEC 2011]

21 Start Where you are.. Use what you have. Do what you can
 By CA. Bhupesh Anand
A: Financial policy making is the backbone of business and very significant to top management
and helps the management to form corporate strategy. It helps in defining the feasible area
of operation for all types of activities and thereby defines the overall framework. Financial

policy comprises of three components (a) Financial resource (b) Financial tools (c) Financial
goals. Management need to ensure that enough funding is available at the right time to meet
the needs of the business. Hence, making of financial policy in taking three importance
decision of business viz. Financing, investing and Dividend are always helpful to the
management to take key corporate decision like expansion, diversification etc.

Q.19 Çontrol need of widely-held company’and çontrol need of closely-held company’.

Explain?
[CS DEC 2011] {CWA June2010}

A: ‘Control need of widely-held company’and control need of closely-held company’.

A closely held company is a company whose common shares are owned by one individual owner
or by a small group of controlling stockholders. This is in contrast to a widely held stock, in
which thousand or even millions of different investors may own shares in a large company.
Closely held stock in typically not publicly traded on exchanges because the small number of
owners rarely sells their shares. A common way that a closely held stock is created is when
as entrepreneur starts and incorporates his or her own business, but retains ownership of
all the company’s outstanding shares.

Q.20 Write the note on Financial distress? {CWA June 2009}[CS DEC 2011]

A: Financial Distress
Generally, the affairs of the firm should be managed in such a way that the total risk-business as
well as financial born by equity shareholders is minimized and is manageable, otherwise the firm will
obviously face difficulties. If cash inflow is inadequate, the firm will face difficulties in payment of
interest and repayment of principal . If the situation continues long enough, a time will come when
the firm wou face pressure from creditors. Failures of sales can also cause difficulties in carrying
out production operations. The firm would find itself in a tight spot. Investors would not invest
further. Creditors would recall their loans. Capital market would heavily discount its securities.
Thus, the firm would find itself in a situation called distress.

Q.21 There is a conflict of goals between management and owners.?

[CS FINAL(OLD)DEC.2010]
A: In a company, the decision-taking authority lies in the hands of the management. Since the
company is a complex organisation of various interested parties, management has the
difficult role of reconciling objectives of these parties. In doing so, management may not
necessarily act in the best interest of the owners (shareholders) and may pursue it own
personal goals. The possibility of pursuing exclusively it own personal goals is considered

22 Start Where you are.. Use what you have. Do what you can
 By CA. Bhupesh Anand
remote because the continuous supervision by the company’s owner, employees, creditors,
customers and government will restrict management’s freedom to act in its own interest. It

is certain that management will like to survive over the long-run. Thus, overall management
objective is very likely to be directly towards this goal.

Q.22 Depreciation is a non-cash item of an expense and it is said that it is a source

of finance.” - Discuss? {CWADec2011}[CSSUGG.2010] {V.V.V.Imp}
A: Depreciation is charged as an item of expense in accounting while calculating profit of an
organisation. Depreciation is gradual decrease in the value of asset due to wear and tear, lapse of
time, obsolescence, exhaustion and accident, etc. Controversy exists among academicians and

business executives regarding depreciation to treat as a source of funds. People who are not in
favour of treating depreciation as a source of funds argue that funds are generated by operating
profits and not merely by making provision for depreciation. If depreciation would have been source
of funds, firms could have improved its funds position just by influencing periodical depreciation
charge. The relevant figure of operating profit is the profit operating funds flow. However, there is
no doubt that it is a non cash expense meaning thereby that no cash outflow results, with the
amount of depreciation which an be used by the management to increase any of the current assets,

pay taxes or dividends etc. Therefore, depreciation may be considered as a source of funds in a
limited sense only. The tax- shield on depreciation is a source of funds.

Q.23 Financial sector acts as conduit for the transfer of financial resources from net
savers to net borrowers.? {Student of the year Q}

A: In any economy, the financial sector plays a major role in the mobilization and allocation
of savings. Financial institutions, instruments and markets which constitute the financial sector act
as conduit for the transfer of financial resources from net savers to net borrowers, i.e. from those
who spend less than they earn to those who spend more than they earn. The Financial sector
performs this basic economic function of intermediation essentially through four transformation
mechanisms :

(i) Liability-asset transformation (i.e., accepting deposits as a liability and converting them into
assets such as loans);
(ii) Size- transformation (i.e., providing large loans on the basis of numerous small deposits);

23 Start Where you are.. Use what you have. Do what you can
 By CA. Bhupesh Anand
(iii) Maturity transformation (i.e. offering savers alternate forms of deposits according to their
liquidity preferences while providing borrowers with loans of desired maturities); and
(iv) Risk transformation (i.e. distributing risks through diversification which substantially
reduces risks for savers which would prevail while directly in the absence of financial
intermediate

Think
it

Our lives are not determined by what happens to us but how we

react to what happens, not by what life brings to us, but by the
attitude we bring to life. A positive attitude causes a chain reaction
to positive thoughts, events, and outcomes. It is a catalyst; a spark
that creates extraordinary results.

I wish to express my great fullness to a large number of discerning

students who offered valuable suggestions and for having spread word
across the student community their positive opinion about the book. The
wide acceptance of the book in all parts of the country gives me boundless
happiness and satisfaction

इस दु नया म असंभव कु छ भी नह ं| हम वो सब कर सकते है ,

जो हम सोच सकते है और हम वो सब सोच सकते है , जो आज
तक हमने नह ं सोचा|

24 Start Where you are.. Use what you have. Do what you can