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Chapter: One
Contents
Finance function as different from Accounts function
Objectives of Financial Management – short-term and long-term
Financial system and markets in India – Government of India, Ministry of Finance
at the helm, statutes, statutory authorities, financial intermediaries, other
financial institutions, agents who operate in the markets etc.
Brief introduction to “Financial Instruments”
Introduction
Financial Management is an integral part of Business Management. Finance is one of the key functions
in an organisation. The other key functions in an organisation are:
Production
Human Resources
Marketing
Each of the above function has got sub-divisions – for example Production has maintenance,
Administration has purchases etc.
Finance deals with financial resources. Financial management as a corollary would deal with
management of financial resources and related areas.
Management of risk in dealing with foreign exchange for imports and exports
Note: The above list is not exhaustive.
Accounts function
Core accounts have to take care of the following areas:
Maintaining accounts on a regular basis for all items of income, expenditure, assets and
liabilities
Conforming to Generally Accepted Accounting Practices (GAAP – India), Accounting principles,
Various Accounting standards of the Institute of Chartered Accountants of India (ICAI),
Requirements under the Companies’ Act like following “Accrual system of accounting” (as
opposed to cash system of accounting), Requirements under The Income Tax Act while
maintaining the Accounts of the limited company
Finalisation of accounts at the end of the accounting period (financial year) and preparation of
final accounts in the formats prescribed in the Companies’ Act – Schedule VI after claiming
depreciation as per provisions of Companies’ Act – Schedule XIV
Conforming to provisions relating to Advance Tax payment in four instalments – first
instalment by 15/6, second instalment by 15/9, third instalment by 15/12 and the last
instalment by 15/3.
Conforming to provisions relating to statutory audit of accounts under the Companies’ Act
Preparation of revenue and capital budgets
Management Information System (MIS) relating to Accounts and Finance
Note: Further details on the above are not given here as they are outside the scope of textbook on
“Financial Management”. As the students can see, most of them are self-explanatory.
Long-term objective
The long-term objective of financial management is to increase the wealth of the shareholders. The
term “wealth” refers to various business assets of the enterprise that are free of debt. This means that
this wealth belongs to the equity shareholders. It is often reflected in the “book value” of the share as
reflected in the balance sheet.
The formula for book value is:
Equity share capital + Reserves and Surplus
Number of equity shares issued
This can be explained through an example.
Example no. 3
Equity share capital = Rs. 100 lacs (paid up capital)
Reserves and surplus = Rs. 200 lacs
Number of shares = 10 lacs with the Face Value being Rs.10/-
Then the book value of the share would be = Rs. 100 lacs + Rs. 200 lacs = Rs. 30/-.
10 lacs shares
This means that at the starting point the book value was Rs.10/- and this has gone up to Rs. 30/- due
to the prudent policy of the management of retaining profits within the organisation. Thus the short-
term objective also is a contributory factor to realising the long-term objective of wealth maximisation.
Some of the measures through which we achieve the long-term objective are:
Strategic financial management decisions relating to expansion, take over of another business,
financial re-restructuring through financial re-engineering (example – swap a costly loan for a
cheaper loan provided the credibility of the firm is quite high), joint venture etc. Thus while
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Carrying too much liquidity involves cost. This cost is referred to as “opportunity cost”. It simply means that by
carrying too much liquidity, the business enterprise has foregone an opportunity of getting a return on such amount
that it will have got by employing the funds in business. On the contrary, carrying too little cash is also risky as the
enterprise may not be able to fulfil its obligations to creditors etc. in time.
The Reserve Bank of India controls the money markets in India. It is known as money market regulator.
Primary market
Primary market in the money market is wherein the Institutions requiring funds issue securities like
treasury bills and get finance and there is no specific market place excepting in the case of treasury
bills. RBI conducts auction of treasury bills after due notice in national dailies and hence this can be
construed as the “market place”.
Secondary market
The secondary market is provided by Discount and Finance House of India Limited (DFHI) a subsidiary
of RBI. It provides a two-way quotation, one for purchasing money market instruments and another for
selling money market instruments. For example, a holder of Treasury bill of Government of India can
sell it to DFHI and anyone wants to purchase treasury bills, he can approach DFHI who can sell it to
him. There is no secondary market for call money or notice money market.
Primary market
There is no specific market place for this. This again, like in the case of money market, facilitates issue
of securities by those who require funds in the medium to long-term. The public issue process is
supervised and controlled by the lead merchant banker/bankers in the case of all public issues.
Primary market ends with the listing of securities on stock exchanges by the Registrar to the Issue.
Details of operators in the primary market have been given under “Agents operating in financial
markets”.
Secondary market
The secondary market begins with the listing of securities on the stock exchanges by the Registrar to
the issue. It has a market place in the form of stock exchanges. Its operations are through share
brokers who are registered with respective stock exchanges. The stock exchanges in turn are
controlled and regulated by SEBI. Details of operators in the secondary market have also been given
under “Agents operating in the financial markets”.
Statutes governing the various segments of the financial markets and the statutory
authorities
Statute means an Act passed either by the Parliament or State legislature.
Money market – No specific statute – controlled by RBI
Capital market – Securities Contracts Regulations Act and Rules as well as SEBI regulations for the
various operators in the Capital market – controlled by SEBI. Mutual Funds also come under the
Regulations of SEBI.
Insurance – Insurance Regulatory and Development Act (IRDA) – controlled by the Insurance
Regulatory and Development Authority coming under GOI, Ministry of Finance
Banking – Banking Regulations Act controlled by RBI
Non-banking Financial Companies (NBFCs – example Kotak Mahindra Finance Company Limited) – Non-
Banking Financial Companies Act of RBI
Functioning of limited companies registered in India – The Companies’ Act – controlled by the Company
Law Board2 (CLB) coming under GOI, Ministry of Finance. The principal officer is known as “The
Registrar of Companies” (ROC).
Foreign Exchange market – Foreign Exchange Management Act and Exchange Control Regulations Act
both coming under the RBI
Some segments of the financial markets like the Indian companies accessing international markets
come directly under the GOI, Ministry of Finance
Special organisations
2
Company Law Board is primarily responsible for conduct of the affairs of limited companies registered in India
under the Companies’ Act. The difference in roles of CLB and SEBI is that the latter is mainly concerned with issue
of securities in the capital market protecting the interests of various kinds of investors. SEBI is not controlling The
Companies’ Act while CLB is not controlling the SCRA. They play complementary roles.
These come under one of the financial market regulators or directly under GOI – Ministry of Finance
All-India Financial Institutions – GOI – MOF
Central Board of Direct Taxes – CBDT – GOI – MOF
Stock Exchanges – SEBI
National Bank for Agriculture and Rural Development (NABARD) – RBI
Institute of Chartered Accountants of India (ICAI) – GOI – MOF
Institute of Cost and Works Accountants of India (ICWA) – GOI – MOF
Institute of Company Secretaries of India (ICSI) – GOI – MOF
Institute of Chartered Financial Analysts of India (ICFAI) – GOI – MOF
Foreign Investment Promotion Board (FIPB) – GOI - MOF
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Merchant banker controls the Primary market and is fully responsible for the issue of public securities like equity
shares, debentures, bonds etc. the capital market instruments. He is the principal operator and controls and
monitors all the other operators in the capital market. He is fully accountable to SEBI for the smooth conduct of the
operations in the capital markets. He has to ensure 100% conformity with SCRA rules and regulations as well as
SEBI rules and regulations.
4
Underwriting in the capital market means giving an undertaking to invest money in securities issued to public
should the issue fail to collect the required amounts as per SEBI rules and regulations. Underwriting as such does
not involve any funds and hence is referred to as “fee based activity”. However once the issue fails to collect the
required amount, the underwriter is expected to make good the deficit amount to the extent undertaken by him.
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Depositories – National level special organisations coming under the
national stock exchanges and assume responsibility for collating
details of ownership of shares issued by a limited company.
Depository participants – Retail level operators who maintain Electronic
Share Accounts of various owners of securities
Financial instruments
Already referred to under financial markets above. For further details, please refer to chapter on
financial sources
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At present, we have two depositories operating at the national level – National Securities Depositories Limited
(NSDL – owned by the National Stock Exchange) and Central Depository Services Limited (CDSL – owned by the
Bombay Stock Exchange). As per capital market regulations, in the secondary market, the securities can be sold
only in the “demat” or electronic form and not in the physical form. Accordingly under the national level
depositories, depository participants operate at the retail level. They maintain the individual demat accounts on
behalf of the shareholders and investors of other securities. These demat accounts are often referred to as
“Electronic Share Accounts”. The DPs transfer the data from the retail level to the national level depositories who in
turn collate information about ownership of securities and submit data to the signatory companies with whom they
have signed contracts.