UNIT-2

What is Financial Management?

Financial Management is all about planning, organizing, directing, and
controlling the economic pursuits such as acquisition and utilization of
capital of the firm. To put it in other words, it is applying general
management standards to the financial resources of the firm.

Scope of Financial Management

To understand the financial management scope, first, it is essential to
understand the approaches that are divided into two sections.

1. Traditional Approach
2. Modern Approach

Approach 1: Traditional Approach to Finance Function

During the 20th century, the traditional approach was also known as
corporate finance. This approach was initiated to procure and manage
funds for the company. For studying financial management, the following
three points were used

(i) Institutional sources of finance.

(ii) Issue of financial devices to collect refunds from the capital market.

(iii) Accounting and legal relationship l between the source of finance and
business.

In this approach, finance was required not for regular business operations
but occasional events like reorganization, promotion, liquidation,
expansion, etc. It was considered essential to have funds for such events
and regarded as one of the crucial functions of a financial manager.

Though he was not accountable for the effective utilization of funds,

however, his responsibility was to get the required funds from external
partners on a fair term. The traditional approach of finance management
stayed until the 5th decade of the 20th century. The traditional approach
only emphasized on the fund’s procurement only by corporations. Hence,
this approach is regarded as narrow and defective.

Limitations of Traditional Approach

 One-sided approach- It is more considerate towards the fund procurement
and the issues related to their administration; however, it pays no attention to
the effective utilization of funds.
 Gives importance to the Financial Problems of Corporations- It only
focuses on the financial problems of corporate enterprises, so it narrows the
opportunity of the finance function.
 Attention to Irregular Events- It provides funds to irregular events like
consolidation, incorporation, reorganization, and mergers, etc. and does not
give attention to everyday business operations.
 More Emphasis on Long Term Funds- It deals with the issues of long-term
financing.

Approach 2: Modern Approach to Finance Function

With technological improvement, increase competition, and the
development of strong corporate, it was important for Management to use
the available financial resources in its best possible way. Therefore, the
traditional approach became inefficient in a growing business
environment.

The modern approach had a more comprehensive analytical viewpoint

with a focus on the procurement of funds and its active and optimum use.
The fund arrangement is an essential feature of the entire finance
function.

The main elements of this approach are an evaluation of alternative

utilisation of funds, capital budgeting, financial planning, ascertainment of
financial standards for the business success, determination of cost of
capital, working capital management, Management of income, etc. The
three critical decisions taken under this approach are.

(i) Investment Decision

(ii) Financing Decision

(iii) Dividend Decision

Features of Modern Approach
The following are the main features of a modern approach.

 More Emphasis on Financial Decisions- This approach is more analytic

and less descriptive as the right decisions for a business can be taken only on
the base of accounting and statistical data.
 Continuous Function- The modern approach is a constant activity where the
financial manager makes different financing decisions unlike the traditional
method,
 Broader View- It gives importance not only to optimum use of finance also
about the fund’s procurement. Similarly, it also incorporates features relating
to the cost of capital, capital budgeting, and financial planning, etc.
 The measure of Performance- Performance of a firm is also affected by the
financial decision taken by the Management or finance manager. Therefore, to
maximize revenue, the modern approach keeps a balance between liquidity
and profitability.

The other scope of financial management also includes the acquisition of

funds, gathering funds for the company from different sources,
assessment and evaluation of financial plans and policies, allocation of
funds, use of funds to buy fixed and current assets, appropriation of funds,
dividing and distribution of profits, and the anticipation of funds along with
estimation of financial needs of the company.

Roles of Financial Management:

 Taking part in utilising the funds and controlling productivity.
 Recognizing the requisites of capital (funds) and picking up the sources for
that capital.
 Investment accords incorporate investment in fixed assets known as capital
budgeting. Investing in current assets are part and parcel of investment
decisions known as working capital decisions.
 Financial decisions associated with the finance raised from different sources
which would rely upon the accord on – the kind of resource, when is the
financing done, cost incurred and the returns as well.
 In the case of dividend decision, the finance manager is the who is
responsible for the accord that is taken by him or her; regarding the net profit
distribution (NPD). However, Net profits are classified into two(2) types:

1. Dividend for shareholders: The rate of dividend and the amount of dividend
has to be decided
2. Retained profits: The amount of contained (retained) gains has to be
ascertained which would rely upon the development and variety of strategies
of the trading concern

Importance of financial Management

The financial management of an organization determines the objectives,
formulates the policies, lays out the procedures, implements the
programmes, and allocates the budgets related to all financial activities of
a business. Through a streamlined financial management practice, it is
possible to ensure that there are sufficient funds available for the
company at any stage of its operations. The importance of financial
management can be assessed by taking a look at its core mandate:

 Availability of sufficient funds

 Maintaining a balance between income and expenses to ensure
financial stability
 Ensuring efficient and high ROI
 Creating and executing business growth and expansion plans
 Safeguarding the organization against market uncertainties through
ensuring buffer funds

Charectstics/Nature of financial Mgt

1. Financial Mgt is an essential part of top mgt
2. Less descriptive and more analytical
3. Continuous function
4. Different from Accounting function
5. Wide scope
6. Centralised nature
7. Measurement of performance
8. Applicable to all types of organisations
Functions of Financial Management

1. Estimation of capital requirements: A finance manager has to make

estimation with regards to capital requirements of the company. This will
depend upon expected costs and profits and future programmes and policies
of a concern.

Estimations have to be made in an adequate manner which increases earning

capacity of enterprise.

2. Determination of capital composition: Once the estimation has been

made, the capital structure has to be decided.

This involves short-term and long-term debt equity analysis. This will depend
upon the proportion of equity capital a company is possessing and additional
funds which have to be raised from outside parties.

3. Choice of sources of funds: For additional funds to be procured, a company

has many choices like-
a. Issue of shares and debentures
 b. Loans to be taken from banks and financial institutions
c. Public deposits to be drawn like in form of bonds.

Choice of factor will depend on relative merits and demerits of each source
and period of financing.

4. Investment of funds: The finance manager has to decide to allocate funds

into profitable ventures so that there is safety on investment and regular
returns is possible.
5. Disposal of surplus: The net profits decision has to be made by the finance
manager. This can be done in two ways:
a. Dividend declaration - It includes identifying the rate of dividends and
other benefits like bonus.
b. Retained profits - The volume has to be decided which will depend
upon expansional, innovational, diversification plans of the company.
6. Management of cash: Finance manager has to make decisions with regards
to cash management.

Cash is required for many purposes like payment of wages and salaries,
payment of electricity and water bills, payment to creditors, meeting current
liabilities, maintenance of enough stock, purchase of raw materials, etc.

7. Financial controls: The finance manager has not only to plan, procure and
utilize the funds but he also has to exercise control over finances.

This can be done through many techniques like ratio analysis, financial
forecasting, cost and profit control, etc.

UNIT-1
agribusiness in India classification and credit need in changing agriculture
scenario
Definition
1. According to William G. Murray, agricultural finance is the
economic study of borrowing of funds by farmers; of the
organization and operation of farm lending agencies; and of
society's interest in credit for agriculture.
Farm Finance is a branch of agricultural economics which deals with the
provision and management of services of financial resources related to the

Farm Finance
1. is not meant merely for more production but also to raise the productivity of
farm resources;
 2. not a mere loan or advance , but it is an instrument to promote the well-
being of the farming community;
3. is not just a science to manage the money, but is an applied science of
allocating scarce resources to derive optimum output; and
4. not a mere social obligation on the society; but it is a lever with backward and
forward linkages to the economic development both at toe micro and macro
level.

At macro level, farm finance may be defined as the study of impact of finance (extended to
the farmers by the intermediaries) on agricultural sector and also on the economy as a
whole. At micro level, farm finance may be defined as the study of these intermediaries who
extend finance to the farming sector and obtain their loanable funds from financial markets.
Thus, farm finance should have the following features:
 finance should be extended to farmers for farm activities;
 finance should stimulate tie productivities of farm resources resulting in higher
economic returns for the investment;
 finance should promote economic development of farm households; and
 finance should be provided by an external agency for strengthening the backward
and forward linkages with country's economic development.
Further, farmers and bankers view farm finance in different ways as detailed
below:

Farmers Lending Agencies

acquire finance for farm needs at proper time extend finance which can be easily collected.
try to get finance at a reasonable cost try to get a reasonable rate of return for capital.
ensure that their own assets are not exposed to high ensure proner degree of liquidity of securities for
risks. safety.

Farmers Lending Agencies

Classification of Agricultural credit

Agricultural credit can be classifified based on purpose, time (repayment period), security,
generation of surplus funds, creditor and number of activities for which credit is provided.
i) Purpose: Based on the purpose for which loan is granted, agricultural credit is categorized
into:
a) Development credit or Investment Credit: This is provided for acquiring durable assets or
for improving the existing assets. Under this, credit is extended for: - purchase of land and
land reclamation. - purchase of farm machineries and implements - development of
irrigation facilities - construction of farm structures - development of plantation and
orchards - develonment of dairy, poultry, sheep/goat, fisheries, sericulture, etc.
b) Production credit: is given for crop, production: Here, the loan amount is used for
purchasing inputs and for paying wages.
c) Marketing credit: It is essential to carry out the marketing functions and to get higher
prices for the produce.
d) Consumption credit: It is the credit required by the farmer to meet his family expenses.

ii) Repayment Period: Based on the period for which the borrower require credit, it is
divided into:
a) Short-Term Credit: It is given to farmers for periods ranging from 6 to 18 months and is
primarily meant to meet cultivation expenses viz., purchase of seed, fertilizer, pesticides and
payment of wages to labourers. It serves as the working capital to operate the farm
efficiently and is expected to be repaid at the time of harvesting / marketing of crops. It.
should be repaid in one instalment.
b) Medium-Term Credit: Repayment is for the period of 2 to 5 years, It is for the purchase of
pump-sets, farm machineries and implements, bullocks, dairy animals and to carry out
minor improvement in the farm. It can be repaid either in half yearly or annual installments.
c) Long-Term Credit: It is advanced for periods more than 5 years and extends even unto
twenty five years against mortagage of immovable property for undertaking development
works viz., sinking wells, purchase of tractor, and rnaking permanent improverments in the
farm. It has to be repaid in half-yearly or annual instalments.

iii) Secutirty: Credit is provided to farmers based on the security offered by them.
a) Farm Mortgage Credit: It is secured against mortgage of land.
b) Collateral Credit or Chattel Credit: It is given against the security of livestock, crop or
warehouse receipt.
c) Personal Credit: It is given based on the character and repaying capacity of the person and
not on any tangible assets. In general, LT credit is usually advanced against security of land
while MT and ST loans are sanctioned against personal and. collateral security.
iv) Generation of Surplus Funds: Based on generation of surplus funds, credit can be
classified as self-liquidating and non-self -liquidating credit.
a) Self Liquidating Credit: In this case, loan amount gets absorbed in the production process
in one year or production period and the additional income generated is sufficient to repay
the entire loan amount.
b) Non-Self Liquidating Credit: Here the resources acquired with the borrowed funds are not
consumed in the production process during the project period. The investment is spread
over a period of several years. The additional income generated in one year is not sufficient
to repay the entire loan amount and hence the repayment is spread over to number of
years.

v) Creditor or Lender wise Credit: Credit can be classified from the point of view of creditor
a) Non - Institutional Agencies: They include money lenders, traders, commission agents,
friends and relatives. This kind of loan is generally exploitative.
b) Institutional Agencies: They include co-operative’s, commercial bank and regional rural
bank.
vi) Number of Activities Served: Based on the number of activities for which amount the
loan can be used, credit can be categorized into
a) single purpose loan and b) composite loan.

Objectives

1. Profit Maximization
A business is set up with the main aim of earning huge profits. Hence, it is
the most important objective of financial management. The finance
manager is responsible to achieve optimal profit in the short run and
long run of the business. The manager must be focused on earning
more and more profit. For this purpose, he/she should properly use
various methods and tools available.

2. Wealth Maximization
Shareholders are the actual owners of the company. Hence, the
company must focus on maximizing the value or wealth of shareholders.
The finance manager should try to distribute maximum dividends among
the shareholders to keep them happy and to improve the goodwill of the
company in the financial market. The declaration of dividend and
payout policy is decided with the help of financial management. A
proper dividend policy related to the declaration of dividends or retaining
the company's profit for future growth and development is part of
dividend decisions. But this is based on the performance of the company
and the amount of profit earned. Better performance means a higher
value of shares in the financial market. In nutshell, the finance manager
focuses on maximizing the value of shareholders.

3. Maintenance of Liquidity
With the help of proper financial management, the manager can
easily monitor the regular supply of liquidity in the company. But it is
not as easy as it sounds. To maintain the proper cash flow, the manager
must keep an eye over all the inflows and outflows of money to reduce
the risk of underflow and overflow of cash. The finance manager is
responsible to maintain an optimal level of liquidity in the
organization. Healthy cash flow means a higher possibility of survival
and success of the business. Because it helps the business to deal with
uncertainty, timely payment of dues, getting cash discounts, making day-
to-day payments without delays, etc.

4. Proper Utilization of Financial Resources

With proper financial management, the organization can make optimum
utilization of financial resources. To achieve this, a financial manager
has various tools that he/she can use. They include managing
receivables, better management of inventory, and effective
payment policy in hand. This will not only save the finance of the
organization but will also reduce the wastage of other resources.

5. Proper Mobilization
Financial management helps in the effective utilization of sources of
finance. It means without wasting them and getting the maximum
benefit from the available resources. The finance manager is responsible
for managing the different sources of funds such as shares, debentures,
bonds, loans, etc. So, after estimating the financial requirements, the
manager must decide which source of the funds he/she should use to
avail the maximum benefit.

6. Decreases the Cost of Capital

This objective includes measuring the cost of capital, risk evaluation,
and calculating the approximate profits out of a particular project.
Financial managers are responsible for the effective investments of
available funds in the current or fixed assets to get the maximum benefits
or ROI.

7. Measure Your Success

The prime motive of any organization is to earn huge profits. So, we can
say that the success of a company is based on its revenue. Financial
management not only helps in earning more revenue but also in
measuring the success of the company. With proper financial reports or
accounts, the organization can compare its current year's performance
with the previous year's performance.

8. Balanced Structure
Financial management also provides a balanced capital structure to the
company. In other words, it brings a proper balance between the various
sources of capital such as loans, equity, bonds, retained earnings,
etc. This balance is required for flexibility, liquidity, and stability in
the organization as well as the economy.

Finance Function
The finance function refers to practices and activities
directed to manage business finances. The functions are
oriented toward acquiring and managing financial
resources to generate profit. The financial resources and
information optimized by these functions contribute to the
productivity of other business functions, planning, and
decision-making activities.
Types of Finance Functions
Investment decision
The investment decision function revolves around capital
budgeting decisions. Capital budgeting in an
organization involves the analysis of investment
opportunities, specifically long-term projects, and
associated cash flows, to determine the profit potential.
They revolve around making a sound investment that must
ripe sufficient and sometimes maximum returns for the
business in the long run. Hence these decisions are
challenging and complex. Payback Period, Net Present Value
(NPV) Method, Internal Rate of Return (IRR), and Profitability
Index (PI) are the popular methods to carry out capital
budgeting.

Financing decision
Expertise in forming financing decisions leads to optimized
capital structure, enhanced performance, and growth.
Financing functions deal with acquiring capital (like when and
how) for the various functioning of the entity, like whether to
use equity capital or debt to finance business events. The
debt and equity mix of an entity are called its capital
structure. The financing decisions always focus on
maintaining good capital structure ratios.
Dividend decision
Companies share profits with their shareholders in the form
of dividends. There are different types of shares,
shareholder’s dividends, and dividend policies.
Furthermore, a company’s dividend policy influences the
company’s market value and stock prices. Hence dividend
decision, including the division of net
income between dividends and retained earnings, is an
important function
Liquidity decision
Liquidity decision generally revolves around working
capital decisions and management. Therefore, the priority is
managing current assets to follow the going concern
concept. The lack of liquidity results in issues like financial
crisis and insolvencies. At the same time, a lot of liquidity
can also lead to more danger. Hence, it is important to have
the right mix of current assets and current liabilities.

Return
Return is associated with gain or loss on money invested in the
market. The rate of return on a security is the annual income
received plus any change in the market price of an asset. Return is
required to maximize the market price of the share but return is
associated with risk because the greater the return, higher the
expectation of risk.

Risk
Since investment decision is based on future estimated returns which are
exposed to different kinds of risk, so forecasts cannot be made with certainty.
Thus, Risk and returns are closely related. A profitable investment may also be
very risky. So, an investor has to manage a trade-off between risk and return.
An investor has to take a decision in investing the firm’s funds in such a way to
optimize return along with minimization of risk. This combination is called the
risk return trade-off. This is the level where the market price of the share is
maximized.

Types of Risk
The investor tries to reduce risk by understanding the risk environment. Risk consists of two
types of exposures i.e. systematic and unsystematic exposures.
I. Systematic risk- Systematic risk is due to the broad spectrum of uncontrollable risk
associated with the business activities within a country. It generates out of
macroeconomic environmental factors such as demand, supply, inflation, change in
interest rates, and change in government policies backed by sociological and political
factors in a country. It is an uncontrollable risk as these forces are beyond the control
 of any individual and thus cannot be minimized by a single firm. They have their
strong influence on the market conditions. Such risks are called market risk and
interest risk and purchasing power risk. These risks affect the cash inflows of a
project. The changes in cash inflows will also bring about change in the profitability
of an investment proposal.

II. Unsystematic risk- Unsystematic risk is a unique risk related to the company
pertaining to the behaviour pattern or internal influence of a firm like the problems
relating to management, staff, expenses, losses, strikes and other issues directly
affect the company’s own operations. These are controllable risks and thus can be
minimized by diversification of investment portfolio.

Risk Return relationship

In the CAPM, the expected return on an asset varies directly with its systematic risk and the
risk premium of market portfolio which is a reward depending on the level of risk-free return
and return on the market portfolio. In other words, the risk premium for an asset or
portfolio is a function of its beta i.e. the risk premium added to the risk-free rate is directly
proportioned to beta.
Thus, the three basic elements required to apply CAPM model are: risk free rate, risk
premium on market portfolio and beta.
Risk free rate- The rate of return available on an assets like T- bills, money market funds or
bank deposits is taken as the proxy for risk free rate as such assets have very low or virtually
negligible default risk and interest rate risk. However, under inflationary conditions, they are
risk less in nominal terms only. In fact, real return (nominal return inflation rate) may
become zero, even negative when inflation wakes up.
Risk premium on market portfolio- The risk premium on market portfolio is the difference
between the expected return on the market portfolio and the risk-free rate of the return.
The CAPM holds that in equilibrium the market portfolio is the unanimously desirable risky
portfolio. It contains all securities in proportion to their market value. In the efficient
portfolio, which enables neither lending and borrowing, the risk premium on the market
portfolio is proportional to its risk and the degree of risk aversion of the average investor.
Beta- Beta measures the risk (Volatility) of an individual security relative to market portfolio.
Accordingly, beta is the co-variance of the security’s return with the market portfolio’s
return, divided by the variance of market portfolio. The co-variance of two securities is the
product of their correlation coefficient and respected standard deviation. The covariance of
the market portfolio with itself is the variance of the portfolio. Thus, the beta of the market
portfolio is one. This classifies all other market portfolios and securities in the two risky
classes. Securities with beta less than one are called defensive security. Security with beta
greater than one is called aggressive security. Risk free security has a beta equal to zero.
 Unit 3
Sources of Finance - Sources of finance for business are equity, debt,
debentures, retained earnings, term loans, working capital loans,
letter of credit, euro issue, venture funding etc.

Equity Share Meaning

An equity share, normally known as ordinary share is a part ownership
where each member is a fractional owner and initiates the maximum
entrepreneurial liability related to a trading concern. These types of
shareholders in any organization possess the right to vote.

Features of Equity Shares Capital

 Equity share capital remains with the company. It is given back only when the
company is closed.
 Equity Shareholders possess voting rights and select the company’s
management.
 The dividend rate on the equity capital relies upon the obtainability of the
surfeit capital. However, there is no fixed rate of dividend on the equity
capital.

Types of Equity Share

 Authorized Share Capital- This amount is the highest amount an
organization can issue. This amount can be changed time as per the
company’s recommendation and with the help of few formalities.
 Issued Share Capital- This is the approved capital which an organization
gives to the investors.
 Subscribed Share Capital- This is a portion of the issued capital which an
investor accepts and agrees upon.
 Paid Up Capital- This is a section of the subscribed capital, that the
investors give. Paid-up capital is the money that an organization really invests
in the company’s operation.
 Right Share- These are those type of share that an organization issue to
their existing stockholders. This type of share is issued by the company to
preserve the proprietary rights of old investors.
 Bonus Share- When a business split the stock to its stockholders in the
dividend form, we call it a bonus share.
 Sweat Equity Share- This type of share is allocated only to the outstanding
workers or executives of an organization for their excellent work on providing
intellectual property rights to an organization.

Merits of Equity Shares Capital

  ES (equity shares) does not create a sense of obligation and accountability to
pay a rate of dividend that is fixed
 ES can be circulated even without establishing any extra charges over the
assets of an enterprise
 It is a perpetual source of funding, and the enterprise has to pay back;
exceptional case – under liquidation
 Equity shareholders are the authentic owners of the enterprise who possess
the voting rights

Demerits of Equity Shares Capital

 The enterprise cannot take either the credit or an advantage if trading on
equity when only equity shares are issued
 There is a risk, or a liability overcapitalization as equity capital cannot be
reclaimed
 The management can face hindrances by the equity shareholders by guidance
and systematizing themselves
 When the firm earns more profits, then, higher dividends have to be paid
which leads to raising in the value of the shares in the marketplace and its
edges to speculation as well

Preference Shares: Meaning, Types,

Features

What Are Preference Shares?

Preference shares commonly known as preferred stocks, are
those shares that enable shareholders to receive dividends
announced by the company before receiving to the equity
shareholders.
If the company has decided to pay out its dividends to
investors, preference shareholders are the first to receive
payouts from the company.
Preference shares are released to raise capital for the company,
which is known as preference share capital. If the company is
going through a loss and winding up, the last payments will be
made to preference shareholders before paying to equity
shareholders.
Preference shares that can be easily converted into equity
 shares are known as convertible preference shares. Some
preference shares also receive arrears of dividends, which are
called cumulative preference shares.
In India, preference shares should be redeemed within 20 years
of issuance, and these types of preference shares are called
redeemable preference shares.
As per the Companies Act 2013, companies do not have any
right to issue irredeemable preference shares in India.

Features of Preference Shares

Several features of preference shares have made normal
investors superior earners even during low phases of economic
growth. The most attractive features of preference shares are
given below:

 They Can Be Converted into Common Stock

Preference shares can be easily converted into common stock. If a
shareholder wants to change its holding position, they are
converted into a predetermined number of preference stocks.
Some preference shares inform investors that they can be
converted beyond a specific date, while others may require
permission and approval from the company’s board of directors to
be converted.

 Dividend Payouts
Preference shares allow shareholders to receive dividend payouts
when other stockholders may receive dividends later or may not be
receiving dividends.

 Dividend Preference
When it comes to dividends, preference shareholders have the
major advantage of receiving dividends first compared to equity
and other shareholders.
  Voting Rights
Preference shareholders are entitled to the right to vote in case of
extraordinary events. However, this happens in only some cases.
Generally, purchasing a company’s stock does not give one voting
rights in the company’s management.

 Preference In Assets
While discussing a company’s assets in the case of liquidation,
preference shareholders have priority over non-preferential
shareholders.

Debentures –
In layman’s term, a Debenture is the acknowledgment of the debt the
organization has taken from the public at large. Debentures are a debt
instrument used by companies and government to issue the loan. The loan is
issued to corporates based on their reputation at a fixed rate of interest.

If a company needs funds for extension and development purpose

without increasing its share capital, it can borrow from the general
public by issuing certificates for a fixed period of time and at a fixed
rate of interest. Such a loan certificate is called a debenture.
Debentures are offered to the public for subscription in the same way
as for issue of equity shares. Debenture is issued under the common
seal of the company acknowledging the receipt of money
Features of Debentures:
The important features of debentures are as follows:
1. Debenture holders are the creditors of the company carrying a
fixed rate of interest.
2. Debenture is redeemed after a fixed period of time.
3. Debentures may be either secured or unsecured.
4. Interest payable on a debenture is a charge against profit and
hence it is a tax-deductible expenditure.
5. Debenture holders do not enjoy any voting right.
6. Interest on debenture is payable even if there is a loss.
Advantage of Debentures:
Following are some of the advantages of debentures:
(a) Issue of debenture does not result in dilution of interest of equity
shareholders as they do not have right either to vote or take part in
the management of the company.
(b) Interest on debenture is a tax-deductible expenditure and thus it
saves income tax.
(c) Cost of debenture is relatively lower than preference shares and
equity shares.
(d) Issue of debentures is advantageous during times of inflation.
(e) Interest on debenture is payable even if there is a loss, so
debenture holders bear no risk.
Disadvantages of Debentures: Following are the disadvantages of
debentures:
(a) Payment of interest on debenture is obligatory and hence it
becomes burden if the company incurs loss.
(b) Debentures are issued to trade on equity but too much
dependence on debentures increases the financial risk of the
company.
(c) Redemption of debenture involves a larger amount of cash
outflow.
(d) During depression, the profit of the company goes on declining
and it becomes difficult for the company to pay interest.
Short Term source
Trade Credit is a financial agreement between business entities such as
suppliers and customers. It allows the exchange of goods and services
without an immediate cash transaction. When a seller permits the buyer
to pay at a future date, it is considered as extending a Trade Credit to
the buyer. Although the credit duration is usually for a fixed period like a
week, month, or year, it can be extended based on the mutual
agreement between the two parties.

Features of Trade Credit

Some of the features of trade credit that makes it an attractive
option for business and buyers include:

1. Trade credit is an internal agreement between buyer and

seller.
2. The credit period is usually for a specific number of days, as
decided by both parties. The credit period is determined by
several factors, including the size of the account, and the
likelihood of the other party breaching their commitment.
3. It helps improve a business’ cash flow while decreasing
working capital requirements.
4. No interest or late fee is charged if payment is made within the
prescribed period.
5. Trade Credit is typically treated as a short-term debt with no
interest.
6. Funding is contingent on the company’s establishment,
financial history, repayment history, and the enterprise’s terms
with the supplier.

Accrued Expenses
Accrued expenses are referred to as those expenses that are incurred, but
are not paid. In other words, these are expenses which are recorded as
expenses in company records, even before payment for the same has
been done.
Accrued expenses are short-term liabilities or current liabilities that are recorded
in the balance sheet of the company. These are also known as accrued liabilities.
Salaries and wages, rent payable, Interest payable
Deferred Income

Deferred income is also known as deferred revenue or

unearned income. As the name suggests, it refers to
income that you have received or not earned yet. Usually,
this is because a customer or client has made an advance
payment for services that have not yet been rendered or
goods that have not yet been delivered.

Deferred revenue is defined as the advance payments that any company

receives for their products or services which will get delivered or
performed in the near future

Bank finance explained

There are several types of bank finance, with different packages available to suit
your needs as your business requirements change.

Short-term finance

 Overdrafts are used in conjunction with business bank accounts and are a
flexible source of working capital for short-term needs.

 Bridging finance is provided by the bank to businesses to maintain cashflow

while awaiting funds from grant cheques, drawdown of commercial mortgages
or loan agreements, or other confirmed sources of future income.

 Invoice finance includes factoring and invoice discounting. It offers ways to

access working capital by unlocking the value of invoices. Interest rates and
charges apply on the cash advanced. Invoice discounting allows you to draw
on funding secured against approved invoices, while in factoring you can sell
invoices to your financier.
Medium-term finance

 Term loans have a fixed or variable interest rate and mature over a one- to
seven-year period. They are typically used to buy fixed assets such as
property or machinery or other purchases of a capital nature.

 Asset finance and leasing options allow businesses to spread the ownership
associated with buying assets. When you buy assets through leasing finance,
the leasing bank buys the equipment for you to use, in exchange for regular
payments.
Long-term finance

 Commercial mortgages are provided by banks to finance the purchase of

business premises. Types of mortgages available include repayment,
commercial endowment or pension. You can get advice on providers of
 commercial mortgages from your bank's business adviser or a commercial
mortgage broker.

 Fixed asset loans are loans for assets that cannot easily be turned into cash -
e.g. property, plant or machinery. The loans can be fixed for up to ten years.
With this type of loan, the asset itself is the collateral and can be repossessed
if you do not maintain repayments.

Unit 7
Capital budgeting

Capital budgeting is the art of deciding how to spend your company’s money
wisely. Basically, it is the process of evaluating potential long-term investment
opportunities to determine which ones will generate the most profit for a business. It
involves analyzing future cash flows, considering the time value of money, and
assessing risks. Ultimately, the goal is to choose investments that will help the
business grow and thrive.

Importance of capital budgeting

Capital budgeting helps businesses prioritize investments and allocate financial
resources more effectively, reducing the risk of investing in unprofitable projects and
maximizing returns. Overall, capital budgeting is an essential tool for businesses to
achieve long-term growth and success.

 Informs long-term investment decisions

 Reduces risk of unprofitable investments
 Maximizes profits by aligning with business goals
 Prioritizes investments and allocates resources efficiently
 Provides a framework for evaluating opportunities
 Promotes long-term growth and success
 Enables planning and budgeting for future investments

Types of capital budgeting

Businesses can use several types of capital budgeting methods to evaluate and
select long-term investment projects.

Here are some common types:

1. Net Present Value (NPV)
This method compares the present value of a project’s cash inflows to the present
value of its cash outflows, taking into account the time value of money.
2. Internal Rate of Return (IRR)
IRR is the discount rate at which the present value of a project’s cash inflows equals
the present value of its cash outflows. It is a measure of the project’s profitability.

3. Payback Period
This method calculates the time it takes for a project to generate enough cash
inflows to recover the initial investment.

4. Profitability Index (PI)

PI compares the present value of a project’s cash inflows to the initial investment. A
PI greater than 1 indicates that the project is profitable.

5. Modified Internal Rate of Return (MIRR)

MIRR is a variation of IRR that assumes that the project’s cash inflows are
reinvested at a predetermined rate.

6. Equivalent Annual Annuity (EAA)

EAA calculates the annual cash inflows that a project would generate if it were an
annuity over its life.

Each of these methods has its advantages and disadvantages, and businesses may
use a combination of methods to evaluate and select investments.