UBA51-Financial Management

ACADEMIC YEAR: 2016 – 2017 REGULATION CBCS - 2012
(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/May2013-2011)
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/May2013-2012)
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.
RAAK/BBA/V.ARUNAGIRI/III YEAR/V Sem/ UBA51 /FINANCIAL

MANAGEMENT/UNIT-1 Answers/VER 2.0
Unit – 1 Answers Page 1 of 17
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An overdraft occurs when money is withdrawn from a bank account and the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.
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) To see that the firm does not raise funds unnecessarily.
15. What is private finance?
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, inter-
company 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.

 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
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.

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.

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).

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. Debenture-
holders are creditors of a company who provide loan to the company.

 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

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 = Budgeted Sales − Break-even Sales
Budgeted Sales − Break-even Sales

MOS =
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

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.

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

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:

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
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.

4. Discuss of the function of financial management.
A financial manager has to concentrate on the following areas of the finance

function.
 Estimating Fi n a n ci a l Req u i r e me n t s : The f i r s t t a s k o f t h e f i n a n c i a l
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

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, Short-
term 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.
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Unit-2 – (CURRENT ASSETS MANAGEMENT)
Type: 100% Theory
Question & Answers
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).

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 c o n c e r n m u s t maintain

certain am o u n t 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.

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 o f 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.

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.
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:

• T o efficient and smooth p r o d u c t i o n process.
• T o maintain optimum i n v en t o r y to maximize the profitability.
• T o meet the seasonal demand of the products.
• To avoid price increase i n future.
• To ensure t h e level and site of inventories required.
• To plan when t o purchase and where t o 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.
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.
GWC =CA
Net Working Capital
Net Working Capital is the specific concept, which, considers both

current assets and current liability of the concern.
Net Working C a p i t a l 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”.

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 1953.
4. 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.

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

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 non-
financial 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. ;

 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,

debtors and receivables and ultimately in cash and this cycle continues again from
cash to purchase of raw material and so on.
The gross operating cycle of the firm = RMCP +WIPCP + FGCP+RCP Where,
RMCP = Raw material conversion period

WIPCP = Work in progress conversion period FGCP
= Finished goods conversion period
RCP = Receivables conversion period
However a firm may acquire some resources of credit and thus defer payments for certain
period. In this case
Net operating cycle period = Gross operating cycle period - Payable deferral
period.
Factors Determining Working Capital Requirements:
The working capital requirement of a concern depends upon a large number of factors,
which are as follow:
1. Nature or Character of Business: Public utility undertakings like Electricity, Water

supply and Railways need very limited working capital because they offer cash sales only
and supply services not products. On the other hand, Trading and Financial firms require
less investment in fixed assets but have to investment large amount in current assets like
inventories, receivables etc.
2. Size of Business: Greater the size of business unit, generally larger will be the
requirement of working capital. In some case even a smaller concern need more working
capital due to high overhead charges, inefficient use of resources etc.
3. Production P o l i c y : The p r o d u c t i o n c o u l d b e k e p t e i t h e r s t e a d y b y
a c c u m u l a t i n g inventories during slack periods with a view to meet high demand
during the peak season or the production could be curtailed during the slack season and
increased during peak season. If the policy is to keep the production steady by
accumulating inventories it will require higher working capital.
4. Seasonal Variations:
a. In certain industries, raw material; is not available throughout year.
They have to buy raw material in bulk during the season to ensure an uninterrupted
flow and process them during the entire year. A huge amount is blocked in the
form of material inventories during such season, which give rise to more working
capital.
5. Working Capital Cycle: In manufacturing concern, the working capital cycle starts with
the purchase of raw material and ends with the realization of cash from the sales of
finished products. This cycle involves purchase of raw material and starts, its conversion
into stock of finished goods through work in progress with progressive increment of labor
and service costs, conversion of finished stock into sales, Debtor and receivables and
ultimately realization of cash and this cycle continues again from cash to purchase of raw
material so on.
6. Rate of Stock Turnover: There is high degree of inverse co relationship between the
quantum of working capital and the velocity or speed with which the sales are affected. A
firm with having a high rate of stock turnover will need lower amount of working capital
as compared to the firm having a low rate of turnover.
7. Credit Policy: Concerns that purchases its requirement on credits and sells its products /
services on cash require lesser amount of working capital. On the other hand, concern
buying its requirement for cash and allow credit to its customers, will need larger amount
of working capital as very huge amount of funds are bound to be tied up in debtors or
bills receivables.
8. Business Cycle: Business Cycle refers to alternate expansion and contraction in general
business activity. In period of boom i.e. when the business is prosperous, there is need for
larger amount of working capital due to increase in sales, rise in prices, and expansion of
business. On the contrary in the times of depression i.e., when there is down swing of
cycle, the business contracts, sales decline, difficulties are faced in collection from
debtors and firms may have a large amount of working capital lying idle.
9. Rate of Growth of Business: For the fast growing concern, larger amount of working
capital is required.
3. Give the important recommendations of chore committee.(April2012)

Emphasized need for reducing the dependence of large and medium scale units of bank
finance for working capital
(2) To follow simplified information system but with penalties with such information is
not forth coming within the specified limit.

cases of merits.

earlier recommended by the Tondon Committee. 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.
4. Describe the factors determining working capital requirements.

Working Capital requirements depends upon various factors. There are no
set of rules or formula to determine the Working Capital needs of the business
concern. The following are the major factors which are determining the Working
Capital requirements.
1. Nature of business: Working Capital of the business concerns largely
depend upon the nature of the business. If the business concerns follow rigid
credit policy and sell goods only for cash, they can maintain lesser amount of

Working Capital. A transport company maintains lesser amount of Working

Capital while a construction company maintains larger amount of Working
Capital.
2. Production cycle: Amount of Working Capital depends upon the length of the
production cycle. If the production cycle length is small, they need to
maintain lesser amount of Working Capital. If it is not, they have to maintain
large amount of Working Capital.
3. Business cycle: Business fluctuations lead to cyclical and seasonal changes in the
business condition and it will affect the requirements of the Working Capital.
In the booming conditions, the Working Capital requirement is larger and in
the depression condition, requirement of Working Capital will reduce. Better
business results lead to increase the Working Capital requirements.
4. Production policy: It is also one of the factors which affects the Working Capital
requirement of the business concern. If the company maintains the
continues production policy, there is a need of regular Working Capital. If the
production policy of the company depends upon the situation or conditions,
Working Capital requirement will depend upon the conditions laid down by
the company.
5. Credit policy: Credit policy of sales and purchase also affect the Working Capital
requirements of the business concern. If the company maintains liberal credit
policy to collect the payments from its customers, they have to maintain more
Working Capital. If the company pays the dues on the last date it will create
the cash maintenance in hand and bank.
6. Growth and expansion: During the growth and expansion of the business
concern, Working Capital requirements are higher, because it needs some
additional Working Capital and incurs some extra expenses at the initial
stages.
7. Availability of raw materials: Major part of the Working Capital
requirements are largely depend on the availability of raw materials. Raw materials
are the basic components of the production process. If the raw material is not
readily available, it leads to production stoppage. So, the concern must
maintain adequate raw material; for that purpose, they have to spend some
amount of Working Capital.
8. Earning capacity: If the business concern consists of high level of earning
capacity, they can generate more Working Capital, with the help of cash from
operation. Earning capacity is also one of the factors which determines the
Working Capital requirements of the business concern.
-----

Unit-3 – (CURRENT ASSETS MANAGEMENT)
Type: 100% Theory
Question & Answers
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).

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 c o n c e r n m u s t maintain

certain am o u n t 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.

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 o f 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.

2. Explain the recommendations of chore committee on working capital finance.

(April/May2013)
Emphasized need for reducing the dependence of large and medium scale units of
bank finance for working capital
(2) To follow simplified information system but with penalties with such
information is not forth coming within the specified limit.
cases of merits.

earlier recommended by the Tondon Committee.
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:

• T o efficient and smooth p r o d u c t i o n process.
• T o maintain optimum i n v en t o r y to maximize the profitability.
• T o meet the seasonal demand of the products.
• To avoid price increase i n future.
• To ensure t h e level and site of inventories required.
• To plan when t o purchase and where t o 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.
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.
GWC =CA
Net Working Capital
Net Working Capital is the specific concept, which, considers both

current assets and current liability of the concern.
Net Working C a p i t a l 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”.

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 1953.
4. 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.

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

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 non-
financial 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. ;

 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,

debtors and receivables and ultimately in cash and this cycle continues again from
cash to purchase of raw material and so on.
The gross operating cycle of the firm = RMCP +WIPCP + FGCP+RCP Where,
RMCP = Raw material conversion period

WIPCP = Work in progress conversion period FGCP
= Finished goods conversion period
RCP = Receivables conversion period
However a firm may acquire some resources of credit and thus defer payments for certain
period. In this case
Net operating cycle period = Gross operating cycle period - Payable deferral
period.
Factors Determining Working Capital Requirements:
The working capital requirement of a concern depends upon a large number of factors,
which are as follow:
1. Nature or Character of Business: Public utility undertakings like Electricity, Water

supply and Railways need very limited working capital because they offer cash sales only
and supply services not products. On the other hand, Trading and Financial firms require
less investment in fixed assets but have to investment large amount in current assets like
inventories, receivables etc.
2. Size of Business: Greater the size of business unit, generally larger will be the
requirement of working capital. In some case even a smaller concern need more working
capital due to high overhead charges, inefficient use of resources etc.
3. Production P o l i c y : The p r o d u c t i o n c o u l d b e k e p t e i t h e r s t e a d y b y
a c c u m u l a t i n g inventories during slack periods with a view to meet high demand
during the peak season or the production could be curtailed during the slack season and
increased during peak season. If the policy is to keep the production steady by
accumulating inventories it will require higher working capital.
4. Seasonal Variations:
a. In certain industries, raw material; is not available throughout year.
They have to buy raw material in bulk during the season to ensure an uninterrupted
flow and process them during the entire year. A huge amount is blocked in the
form of material inventories during such season, which give rise to more working
capital.
5. Working Capital Cycle: In manufacturing concern, the working capital cycle starts with
the purchase of raw material and ends with the realization of cash from the sales of
finished products. This cycle involves purchase of raw material and starts, its conversion
into stock of finished goods through work in progress with progressive increment of labor
and service costs, conversion of finished stock into sales, Debtor and receivables and
ultimately realization of cash and this cycle continues again from cash to purchase of raw
material so on.
6. Rate of Stock Turnover: There is high degree of inverse co relationship between the
quantum of working capital and the velocity or speed with which the sales are affected. A
firm with having a high rate of stock turnover will need lower amount of working capital
as compared to the firm having a low rate of turnover.
7. Credit Policy: Concerns that purchases its requirement on credits and sells its products /
services on cash require lesser amount of working capital. On the other hand, concern
buying its requirement for cash and allow credit to its customers, will need larger amount
of working capital as very huge amount of funds are bound to be tied up in debtors or
bills receivables.
8. Business Cycle: Business Cycle refers to alternate expansion and contraction in general
business activity. In period of boom i.e. when the business is prosperous, there is need for
larger amount of working capital due to increase in sales, rise in prices, and expansion of
business. On the contrary in the times of depression i.e., when there is down swing of
cycle, the business contracts, sales decline, difficulties are faced in collection from
debtors and firms may have a large amount of working capital lying idle.
9. Rate of Growth of Business: For the fast growing concern, larger amount of working
capital is required.
3. Give the important recommendations of chore committee.(April2012)

Emphasized need for reducing the dependence of large and medium scale units of bank
finance for working capital
(2) To follow simplified information system but with penalties with such information is
not forth coming within the specified limit.

cases of merits.

earlier recommended by the Tondon Committee. 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.
4. Describe the factors determining working capital requirements.

Working Capital requirements depends upon various factors. There are no
set of rules or formula to determine the Working Capital needs of the business
concern. The following are the major factors which are determining the Working
Capital requirements.
1. Nature of business: Working Capital of the business concerns largely
depend upon the nature of the business. If the business concerns follow rigid
credit policy and sell goods only for cash, they can maintain lesser amount of

Working Capital. A transport company maintains lesser amount of Working

Capital while a construction company maintains larger amount of Working
Capital.
2. Production cycle: Amount of Working Capital depends upon the length of the
production cycle. If the production cycle length is small, they need to
maintain lesser amount of Working Capital. If it is not, they have to maintain
large amount of Working Capital.
3. Business cycle: Business fluctuations lead to cyclical and seasonal changes in the
business condition and it will affect the requirements of the Working Capital.
In the booming conditions, the Working Capital requirement is larger and in
the depression condition, requirement of Working Capital will reduce. Better
business results lead to increase the Working Capital requirements.
4. Production policy: It is also one of the factors which affects the Working Capital
requirement of the business concern. If the company maintains the
continues production policy, there is a need of regular Working Capital. If the
production policy of the company depends upon the situation or conditions,
Working Capital requirement will depend upon the conditions laid down by
the company.
5. Credit policy: Credit policy of sales and purchase also affect the Working Capital
requirements of the business concern. If the company maintains liberal credit
policy to collect the payments from its customers, they have to maintain more
Working Capital. If the company pays the dues on the last date it will create
the cash maintenance in hand and bank.
6. Growth and expansion: During the growth and expansion of the business
concern, Working Capital requirements are higher, because it needs some
additional Working Capital and incurs some extra expenses at the initial
stages.
7. Availability of raw materials: Major part of the Working Capital
requirements are largely depend on the availability of raw materials. Raw materials
are the basic components of the production process. If the raw material is not
readily available, it leads to production stoppage. So, the concern must
maintain adequate raw material; for that purpose, they have to spend some
amount of Working Capital.
8. Earning capacity: If the business concern consists of high level of earning
capacity, they can generate more Working Capital, with the help of cash from
operation. Earning capacity is also one of the factors which determines the
Working Capital requirements of the business concern.
-----
UBA51 - FINANCIAL MAGEMENT

COST OF CAPITAL BASIC CONCEPTS
Type: 100% Theory
Questions & Answers
PART A – QUESTIONS AND ANSWERS
1. What is the Meaning of Cost of Capital?

The term Cost of capital refers to the minimum rate of return a firm must earn
on its investment so that the market value of the company’s equity shares does not
fall. It refers as cut –off rate, target cost, hurdle cost, minimum rate of return and
standard cost.
2. What are the basic concepts of Cost of capital?

 Not a cash cost
 Minimum rate of return
 Consideration of Risk Premium
3. Explain Business Risk?

The risk to the firm to the firm of being unable to cover operating costs is
assumed to be unchanged. This means that the acceptance of a given project does not
affect the firm’s ability meet operating costs.
4. Define cost of capital?

According to James C Van Horne, ”A cut –off rate for the allocation of capital
to investments of projects. It is the rate of return on a project that will leave
unchanged the market price of the stock.”
5. What is average cost?

The average cost of capital is the weighted average of the costs of each
component of funds employed by the firm.
RAAK/ B.B.A/V.ARUNAGIRI/III YEAR/VSem/UBA51/FINANCIAL

6. What is Implicit cost?

The implicit cost is the rate of return associated with the best investment
opportunity for the firm and its shareholders that will be foregone if the projects
presently under consideration by the firm were accepted.
7. What is Marginal cost?

Marginal cost of capital, on the other hand, is the weighted average of cost of
new funds raised by the firm. For capital budgeting and financing decision, the
marginal cost of capital the most important factor to be considered.
8. State capital structure Decisions?

While designing an optimal capital structure, the firm has to bear in mind the
objective of minimizing the cost of capital so that the market value of the firm is
minimized. The mode of financing is determined on the basis of the cost of financing.
9. What is cost of Retained Earnings?

The cost of retained earnings may be considered as the rate of return which
the existing shareholders can obtain by investing the after-tax dividends in alternative
opportunity of equal qualities.
10. What is optimal capital structure?

Capital structure represents the relationship among different kinds of long
term capital. Normally, a firm raises long term capital through the issue of shares-
common shares, sometimes accompanied by preference shares.
11. What is financial leverage?

The use of long-term fixed interest bearing debt and preference share capital
along with equity share capital is called financial leverage or trading on equity. The
use of long-term debt magnifies the earnings per share if the firm yields a return
higher than the cost of debt.
12. What is EPS Analysis?

This analysis is an important tool of measuring a company’s performance.
Normally a financial plan that will give maximum value of EPS will be selected as
the desirable mix. An obvious objection leveled against the use of EBIT/EPS
analysis is that it is a useful performance criterion but not a decision criterion.

13. What are the various sources of long term funds?

 Equity shares
 Debentures
 Preference shares
 Retained earnings
14. What is an equity share?

Equity share, earlier, known as ordinary shares or common shares. Equity
shareholders are the real owners of the company as they have the voting rights and
enjoy decision-making authority on important matters, related to the company.
15. What is a Preference share?

Preference share represent a hybrid form of financing-it par take some
characteristics of financing-it par takes some characteristics of equity and some
attributes of debentures.
16. What is Debentures?

A debenture is an instrument executed by the company under its common seal
acknowledging indebtedness to some person or persons to secure the sum advanced.
17. What is operating leverage?

Operating leverage is concerned with the cost structure of a firm, i.e., the
existence of fixed nature of cost. The operating leverage occurs when the firm has
fixed cost which can be recovered irrespective of changes in sales volume.
18. What is zero-based Budgeting?

Zero Base Budgeting is a management tool for providing a system for a
careful consideration of activities in the context of budget requests and annual
planning. It is thus a technique which was originally devised to help management in
the difficult task of allocating limited resources more efficiently between projects and
other cost items in the service or support.
19. What is composite leverage?

Composite leverage, thus, expresses the relationship between revenue on
account of sales (i.e., contribution or sales less variable cost) and the taxable income.

It helps in finding out the resulting percentage change in taxable income on account
of percentage change in sales.
20. Define leverage?

According to James C.Van Horne, “Leverage may be defined as the
employment of an asset of funds for which the firm pays cost or fixed return. The
fixed cost or return may be thought of as the fulcrum of Lever.”
PART B– QUESTIONS
1. What are the Basic concepts of Cost of Capital?
 A firm raises funds from various sources, which are called the components of
capital. Different sources of fund or the components of capital have different
costs
 The firm invests the funds in various assets. So it should earn returns that are
higher than the cost of raising the funds. In this sense the minimum return a
firm earns must be equal to the cost of raising the fund.
 On the other hand from the viewpoint of application of funds, it is the
required rate of return that a firm tries to achieve. The cost of capital is the
average rate of return required by the investors who provide long-term funds.
 It is the yardstick to evaluate the worthiness of an investment proposal. In this
sense it may be termed as the minimum rate necessary to attract an investor to
purchase or hold a security.
 This foregone return then is the opportunity cost of undertaking the
investment and consequently, is the investor’s required rate of return. This
required rate of return is used as a discounting rate to determine the present
value of the estimated future cash flows.
 Thus the cost of capital is also referred to as the discounting rate to determine
the present value of return. Cost of capital is also referred to as the breakeven
rate, minimum rate, cut-off rate, target rate, hurdle rate, standard rate, etc.
 In the operational sense, cost of capital is the discount rate used to determine
the present value of estimated future cash inflows of a project. Thus, it is the

rate of return a firm must earn on a project to maintain its present market
value.
2. Explain the significance of Cost of Capital?
(i) Investment Evaluation
The primary objective of determining the cost of capital is to evaluate a project.

Various methods used in investment decisions require the cost of capital as the
cut-off rate. Under net present value method, profitability index and benefit-cost
ratio method.
(ii) Designing Debt Policy

The cost of capital influences the financing policy decision, i.e. the proportion of
and equity in the capital structure. Optimal capital structure of a firm can
maximize the shareholders’ wealth because an optimal capital structure logically
follows the objective of minimization of overall cost of capital of the firm.
(iii) Project Appraisal

The cost of capital is also used to evaluate the acceptability of a project. If the
internal rate of return of a project is more than its cost of capital, the
project is considered profitable. The composition of assets, i.e. fixed and
current, is also determined by the cost of capital. The composition of assets,
which earns return higher than cost of capital, is accepted
3. What are the compositions of capital structure?
1. Owner’s Capital
(a) Equity Shares:
Equity shares are fundamental and basic source for financing the activities of
business. They own the company and bear the ultimate risk associated with
ownership
(b) Preference shares:

Those shares which carry following preferential rights are termed as

preference shares. A preferential right as to the payment of dividend during their
lifetime of a company.
2. Borrowed Capital
(a) Debentures
A debenture is an acknowledgement of debt of loan raise by a Company
Company has to pay interest to debenture holders at an agreed rate under
contractual obligation.
(b) Term Loans
Term loans are loans provided by banks and other financial institutions which
carry fixed rate of interest for a period of three or more years .Terms loans
may be mortgaged or simple.
4. What are the features of Equity shares?

(I) Maturity
Equity share provide permanent capital to the company, which is not under
contractual obligation to refund it during its lifetimes. Shareholders can demand
their capital only if the event of liquidation and that too when funds are left after
covering all prior claims.
(II) Claims on Income

Equity shareholders are residual owners whose claim on income arises only when
claims of creditors and preferred stock-owners are met. In many instances, residual
owners do not get anything if income of the firm was just sufficient to satisfy the
claim of creditors.
(III) Cost of Equity

The cost of equity capital is higher than any other long-term source of finance.
firstly, since the equity dividends are not tax deductible expenses as the interest is
and secondly, the high cost of issue and the risk factor associated with it makes the
cost equity higher.
(IV) Claims on Asset

Being residual owners, equity shareholders are last claimants to assets of the firm. In
the event of winding up of the firm’s business assets, are disposed off to satisfy the
claims of the creditors and also preferred stockholders prior to equity stockholders.

(V) Control
The risk of loss associated with equity share is compensated to some extent by
controlling power that rests with residual owners. Equity shareholders have
unchallenged voice in management. Whatever control the stockholders retain is
exercised primarily through the voting privilege.
5. Explain the features of Preference share?

A. Accumulation of Dividends
Preference shares may be cumulative or non-cumulative with respect to
dividends .Barring a few exceptions, preference shares in India carry a
cumulative feature with respect to dividends. The unpaid dividends on
cumulative preference share are carried forward and payable when the dividend
is resumed.
B. Call-Ability
The terms of preference share issue may contain a call feature by which the
issuing company enjoys the right to call the preference shares, wholly or
partly, at a certain price.
C. Convertibility
Preference shares may sometimes be convertible into equity shares. The
convertible preference shares enjoy the option of converting preference shares
into equity share at a certain ratio during a specified.
D. Redeem ability
Preference shares may be perpetual or redeemable .A perpetual preference share

has no maturity period, whereas a redeemable preference share has a limited life
after which it is supposed to be retired.
F. Voting power
Before the commencement of the companies act, 1956, companies could issue
preference shares carrying voting rights. Preference share issued after the
commencement of the companies Act, 1956 do not carry voting right.

6. What are the disadvantages of Debentures?
I. Disadvantages to company
(1) Fixed charge on Assets

Debentures carry a fixed charge on all assets of the company hence the company
cannot raise loan on such assets again, if needed.
2) Fixed Burden
Interest payable on debentures is a charge on the profits of the company. It will
be paid even if there is not profit.
3) Risk of Winding-Up
The debenture holders have a right to claim winding-up of the company, in case,
the interest on debentures are and paid by the company, in case , the interest on
debentures are and paid by the company.
II. Disadvantages to Investors
(1) No control
Debentures holders are creditors and not the owners of company and hence get
no controlling authority over the affairs of the company.
(2) No Extra profits
Debentures holders get a fixed income as interest irrespective of the quantum
of profits earned by the company.
(3)Uncertainty
In case of redeemable debentures payable within a specified period, investors
have uncertainty in their minds as to their redemption.

PART C– QUESTIONS
1. Explain the factors affecting the cost of capital? How it is important?
(1) General Economic Conditions

(a) General economic conditions determine the demand for and supply of capital
within the economy, as well as the level of expected inflation. This economic
variable is reflected in the risk less rate of return.
(b) This rate represents the rate of return on risk- free investments, such as the
interest rate on short-term government securities. In principle, as the demand
for money in the economy changes relative to the supply, investors alter their
required rate of return.
(c) For example, if the demand for money increases without an equivalent
increase in the supply, lenders will raise their required interest rate. At the
same time, if inflation is expected to deteriorate the purchasing power of the
euro, investors require a higher rate of return to compensate for this
anticipated loss.
(2) Market Conditions

(a) When an investor purchases a security with significant risk, an opportunity for
additional returns is necessary to make the investment attractive. Essentially, as
risk increases, the investor requires a higher rate of return.
(b) This increase is called a risk premium. When investors increase it is required
rate of return, the cost of capital rises simultaneously. Remember we have defined
risk as the potential variability of returns.
(c) If the security is not readily marketable when the investor wants to sell, or
even if a continuous demand for the security exists but the price varies
significantly, an investor will require a relatively high rate of return..
(3) Operating and Financing Decisions

(a) Risk, or the variability of returns, also results from decisions made within the
company. Risk resulting from these decisions is generally divided into two
types: business risk and financial risk.
(b) Business risk is the variability in returns on assets and is affected by the
company’s investment decisions. Financial risk is the increased variability in

returns to common stockholders as a result of financing with debt or preferred

stock. As business risk and financial risk increase or decrease, the investor’s
required rate of return (and the cost of capital) will move in the same
direction.
(4) Amount of Financing
a) The last factor determining the corporation’s cost of funds is the level of
financing that the firm requires. As the financing requirements of the firm
become larger, the weighted cost of capital increases for several reasons.
b) For instance, as more securities are issued, additional flotation costs ,or the
cost incurred by the firm from issuing securities, will affect the percentage
cost of the funds to the firm. Also, as management approaches the market
for large amounts of capital relative to the firm’s size, the investors’
required rate of return may rise.
c) Suppliers of capital become hesitant to grant relatively large sums without

evidence of management’s capability to absorb this capital into the
business. This is typically too much too soon.
2. State the various sources of long – term funds?
 Equity Shares
(i) Equity shares are, earlier, known as ordinary shares or common shares.
Equity shareholders are the real owners of the company as they have
the voting rights and enjoy decision-making authority on important
matters, related to the company.
(ii) Therefore, equity shares are known as ‘Variable income security’.
They are the last one to get repayment in the event of liquidation of the
company.
 Preference Shares
(i) Preference capital represents hybrid form of financing- It par takes
some characteristics of equity and some attributes of debentures. It
resembles equity in the following ways.
(ii) Preference dividend is payable only our distributable profits:
(iii) Preference dividend rate on preference capital usually fixed
(iv) Preference shareholders do not normally enjoy the right to vote.

 Debentures
(i) A debenture is an instrument executed by the company under its
common seal acknowledging indebtedness to some person or persons
to secure the sum advanced.
(ii) Debenture is an instrument issued by the company under this common
seal acknowledging a debt and setting forth the terms under which
they are issued and are to be paid.
 Retained Earning
(i) Retained earnings are also referred as plugging back of profits means
the reinvestments by concern of its surplus earnings in its business.
(ii) It is an internal source of fiancé and is most suitable for an established
firm for its expansion, modernization and replacement, etc.
(iii) Excessive report to retained earnings may lead to monopolies, misuse
of funds over-capitalization and speculations, etc.
3. What are the advantages and disadvantages of Zero-based Budgeting?
` Advantages of Zero based Budgeting
 It provides a basis for evaluating decision packages on the basis of cost-

benefit considerations.
 It reduces inefficiency and achieves high level of effectiveness
 It is a logical extension of program budgeting .Hence the importance is
ranking in the order of priorities.
 It can be applied to cost-reduction programs.
 It ensures thorough examination of every function or activity.
 Scarce resources can be utilized effectively.
 The performance of line managers can be judged against their commitments
and performance thereof.
 ZBB integrates planning, budgeting and control into a single process.
 It provides a good training to lower and middle managers in regard to the
goals, objectives, operations and functions of the organization and develops a
talented and skilled management team.

Disadvantages of zero based Budgeting
 It is not suitable for all the activities in an organization.

 It has limited application in a profit-making organization. In this case, it
can be applied in case of worker’s welfare measures.
 It is not advantageous to apply in R and D activities where it is difficult to
define the objectives and goals
 It is not a panacea for curing all management ills
 ZBB is indifferent as to whether total budget is increasing or decreasing.
 It takes more time and efforts
 Managers often justify current level as minimum level of funding.

UBA 51- FINANCIAL MAGEMENT

UNIT -V FINANCIAL INFORMATION SYSTEM
Type: 100% Theory
PART A – QUESTIONS AND ANSWERS
1. What is financial intelligence? (Apr/May 2013)

Financial intelligence (FININT) is the gathering of information about the financial
affairs of entities of interest, to understand their nature and capabilities, and predict
their intentions. Generally the term applies in the context of law enforcement and
related activities
2. Name any four financial software packages. (2013 Apr/May)

1. Ready Ratios
2. Ariba discount Professionals
3. Oracle PeopleSoft cash management
4. Quorum Capital Budgeting Track
3. What is bank credit?

The borrowing capacity provided to an individual by the banking system, in the form
of credit or a loan is called Bank credit .The total bank credit the individual has is the
sum of the borrowing capacity each lender bank provides to the individuals.
4. What is book value? (Apr/May 2012)

The Book value of an asset is the value of that asset on the “Books” (balance sheet) of
the company. The book value is not necessarily the same as the fair market value
(amount the asst could be sold for on the open market)
5. What is financial ratio?

A financial ratio or accounting ratio is a relative magnitude of two selected
numerical values taken from an enterprise's financial statements. Often used in
accounting, there are many standard ratios used to try to evaluate the overall financial
condition of a corporation or other organization. Financial ratios may be used by
managers within a firm, by current and potential shareholders (owners) of a firm, and
by a firm's creditors.
RAAK/ B.B.A /III YEAR/VSem/S.MANIKKAVALLI/UBA 51/FINANCIAL

MANAGEMENT/UNIT-5Answers/VER 1.1
6. What is budget planning?

Financial budget planning uses Performa or projected financial statements that serve
as formal documents of management’s expectations regarding sales, expenses and
other financial transactions. Thus financial budgets are tools used both for planning as
well as control.
7. What is financial reporting?

The use of financial information system enables companies to generate multiple
financial reports accurately and consistently. Generation of financial statements both
for internal reports as well as for shareholder information takes less effort because of
the automatic updating of the general ledger.
8. What is FIS?
Financial information is the lifeblood of a business enabling ensures an appropriate,
cost-effective financial information system (FIS) is installed for timely, relevant and
accurate information to support better business decisions.
9. What is funds management?

Financial information systems help to manage the organization’s liquid assets, such as
cash or securities, for high yields with the lowest degree of loss of loss risk.
10. What is internal auditing?

The audit function provides an independent appraisal of an organization’s accounting,
financial, and operational procedures and information. All large firms have internal
auditors, answerable only to the audit committee of the Board of Directors.
PART B– QUESTIONS
1. What are the managerial uses of financial information system? (Apr/May 2013)
1. General ledger:
The main use of financial information system is the automatically updates all the
transactions in the General Ledger . It also provides and accurate and permanent
record of all historical transactions.
2. Cash Management:
Cash Management refers to the control, monitoring and forecasting of cash for
financing needs. Use of financial information system helps companies track the
flow of cash through accounts receivable and accounts payable accurately.
3. Budget Planning;

Financial information system helps organizations evaluated “what if” scenarios.

Financial information system serves as a decisions-making tool helping in
choosing approropriate financial goals.
4. Financial Reporting:
The use of financial information system enables companies to generate multiple
financial reports accurately and consistently.
5. Financial Modeling:
A financial model is a system that incorporates mathematics, logic and data in
the form of a large database. Financial information system enable organizations
to store a large amount of data.
2. What are the processes of introducing financial Information system?

Preparatory
 Preliminary concept design including an institutional and organizational
assessment.
 Analysis of the key problem areas and ongoing reform programmes ,
 Feasibility study
 Design project and draft project proposal
Design
 Develop functional specification.
 Outline Information Technology (IT) strategy, including hardware and
organizational issues.
 Prepare tender documents.
Procurement
 Issue tender for hardware and software and associated requirements.
 Evaluation of bids and award contract.
Implementation
 Configuration analysis and specify and additional IT, infrastructure, and
communication requirements.
 Detailed business process and gap analysis mapping required functionality to
package and identifying and specifying detailed parameterization,
customization, procedural etc,. Changes.

3. Name 6 national periodical, journals and magazines ,6 Indian and 6 international
periodical and journals (Apr/May 2012)
6 National periodicals, Journals and Magazines

National Periodicals: Hindu, Business line, economic times, Business standard,

times of India and Indian express
National Journals: According research behavioral finance, Bank management,
financial economics finance India, and financial risk management.
National Magazines: India Today, The week, outlook, Issues and Concerns,
Readers Digest, and Chronicle Civil Service.
6 International Periodicals and Journals

International Periodicals: Big journals, Business Review USA, Financial times
International Business times, Money week and strategy.
International journals
Journal of Asian Business Management, Journal of International Business and
Finance, International of Financial Economics and econometrics, International
economics and finance journal and international journal statistics science.
4. What are the features of Financial Information system?
 Management Tool:
When developing an FIS it is important that is cater to management needs-not just
those of the central agencies, but also line agencies .Mover over, as a management
tool it should support the management of change. It must be viewed as an integral
part of budget system reform-hence not be designed just to meet present
requirements, but also to support those needs that are likely to arise as parallel
budget reforms are implemented.
 Providing wide Range of Non-Financial and Financial Information:

As a tool of management it should provide the information required for decision –
making for this purpose, it is anchored in the government accounting system, and
should be designed to perform all necessary accounting functions as well as
generate custom reports for internal and external use.
 System:
Its role is to connect, accumulate, process, and then provide information to all
parties in the budget system on a continuous basis. All participants in the system,
therefore, need to be able to access the system, and to derive the specific
information they require to carry out their different functions.

5. Explain disadvantages of financial information system?
1) It tends to be expensive and difficult to design and build.
2) When a system is large, the problems associated with it tend to be bigger and
more complicated.
3) Since these systems are highly coordinated and operated to produce synergistic
results, sub-system failures may disrupt the entire system.
4) Maintaining accessibility, privacy, and security of information becomes more

difficult.
PART C– QUESTIONS
1. Describe the components of Financial Information System? (Apr\May 2013)
1) Financial Accounting
 Financial accounting is focused on providing accounting reports and
analysis to other areas of the business. Financial accountants are
responsible for the creation and issuing of the company's financial
statements, providing accurate and timely information to management
and ensuring that all regulatory reporting requirements are met.
 In financial accounting, the goal is to consistently provide the valuable,
accurate and reliable information. The issuing of the financial statements
is the responsibility of the financial accounting department.
 These statements summarize the business's activities for the year and are
used by shareholders, banks, employee bargaining units, and the general
public to evaluate the financial worth of the company. The statements are
audited by independent accountants to validate the information and
provide assurance to readers.
2) Funds Management
 The management of the cash flow of a financial institution. The fund’s
manager ensures that the maturity schedules of the deposits coincide with
the demand for loans. To do this, the manager looks at both the liabilities
and the assets which influence the bank’s ability to issue credit.

2. Explain Financial Information System Model?
The financial system is probably the most important single management

information system in the company, and is most companies it is the oldest and best
developed.
These systems basically deal with large amount of data developed. These systems
basically deal with large amounts of data and involve planning in the financial sector
.However the budgeting functions performed is wholly futuristic. Periodically the
management approves a financial plan (Master budget) that assigns responsibility for
maintaining incomes, investments and costs within standard limits. These plans are the
basis for periodic financial reports and these reports are used by the system for exercising
control and for futuristic planning.
The major operating systems of a company along with their respective functions merge or
integrate with the accounting and financial information system to facilitate financial
reporting and for management information for planning and control. Moreover, the
financial system has a very significant impact on other systems when one considers that
the ultimate common denominator of many operating decisions is the dollar. Perhaps,
billing (invoice preparation) is the most widely used data processing application among
financial information system.

3. What are the advantages of Financial Information system?
 Integrated financial information

 Flexibility of reporting and additional control over expenditure.
 Less administration required within the business
 Tighter views of budgets versus actual
 Information can be presented in a relevant framework.
 Data can be better analyzed and categories before they are reported and/or
disseminated
 Information has greater opportunity for reaching decision-makers on a timely
basis.
 The opportunity to design the system to produce data to meet users’ needs is
facilitated.
 The opportunities for data analysis and conducting cost-benefit analysis are
enhanced.
 There is greater opportunity to standardize, centralize, and increase the
consistency of information.


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UBA51-Financial Management

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ACADEMIC YEAR: 2016 – 2017 REGULATION CBCS - 2012

(UBA51) – FINANCIAL MANAGEMENT

1. Define Financial Management.

2. What is financial Planning? (April/May2013-2011)

Financial planning means deciding in advance, the financial activities to be carried

Operating leverage is a measure of a firm's level of fixed costs relative to its

4. What is financial forecasting? (April/2012)

A financial forecast is simply a financial plan or budget for your business. It is an

5. Define finance Function.(April2011)

RAAK/BBA/V.ARUNAGIRI/III YEAR/V Sem/ UBA51 /FINANCIAL

6. What is bank overdraft?(April2011)

7. What is Profit- Volume ratio?(April2011)

DEFINITION of 'Breakeven Point - BEP' 1. In general, the point at which gains

9. What is cash forecast?(2011)

Cash flow forecasting or cash flow management is a key aspect of financial

10. What is Leverage?

(1) The degree to which an investor or business is utilizing borrowed money.

11. What do you understand by Business Finance?

12. State the primary objective of financial management.

To maximize the shareholders wealth.

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.

It is concerned with procuring money for private organization and management of

18. What is corporation finance?

 Acquiring Sufficient and Suitable Funds.

RAAK/BBA/V.ARUNAGIRI/III YEAR/V Sem/ UBA51 /FINANCIAL

 Proper Utilization of Funds.

1. What are the objectives of financial Management? (April2011-April/May2013)

2. What are different tools of financial analysis? (April/May2013)

 Comparative financial statements

Comparative financial statements:

Comparative study of financial statements is the comparison of the financial

RAAK/BBA/V.ARUNAGIRI/III YEAR/V Sem/ UBA51 /FINANCIAL

Common size statements:

Ratio analysis is used to evaluate relationships among financial statement items.

Funds flow analysis:

Cash flow analysis:

Financial statement analysis can be performed by employing a number of methods or

RAAK/BBA/V.ARUNAGIRI/III YEAR/V Sem/ UBA51 /FINANCIAL

2. Cash Flow Analysis:

3. Comparative Financial Statements:

Comparative financial statement is an analysis of financial statements of the

4. Why is the study of the relationship of cost-Volume profit important to

Cost-volume-profit (CVP) analysis expands the use of information provided by

Cost-volume-profit analysis employs the same basic assumptions as in breakeven

RAAK/BBA/V.ARUNAGIRI/III YEAR/V Sem/ UBA51 /FINANCIAL

 Get planning closer to your business strategy?

RAAK/BBA/V.ARUNAGIRI/III YEAR/V Sem/ UBA51 /FINANCIAL

Break- even chart:

Criticism of break even analysis:

Total cost= fixed cost + variable cost

MOS = Budgeted Sales − Break-even Sales

Budgeted Sales − Break-even Sales

1. Explain the relationship between financial management and other areas of

1. Financial Management and Economics:

RAAK/BBA/V.ARUNAGIRI/III YEAR/V Sem/ UBA51 /FINANCIAL

2. Financial Management and Accounting:

3. Financial Management or Mathematics

4. Financial Management and Production Management:

5. Financial Management and Marketing:

RAAK/BBA/V.ARUNAGIRI/III YEAR/V Sem/ UBA51 /FINANCIAL

6. Financial Management and Human Resource

2. Explain the various sources of long term finance.(April2011)

RAAK/BBA/V.ARUNAGIRI/III YEAR/V Sem/ UBA51 /FINANCIAL

Preference shares may be classified into the following major types: