FINANCIAL MANAGEMENT THEORY AND PRACTICE

FINANCIAL MANAGEMENT
Theory and Practice

SATISH B. MATHUR
Ph.D. (Business Management), CAIIB.
Mentor, Mathur Management Consultants, (MMC), Lucknow
Former Professor of Finance and Accounting
Indian Institute of Management, Lucknow, (IIML),
Administrative Staff College of India, (ASCI), Hyderabad, and
State Bank Staff College, (SBSC), Hyderabad, India

With a Foreword by
DR. C. RANGARAJAN
Chairman, Economic Advisory Council to the Prime Minister
Government of India, New Delhi, (India)
Former Governor, Reserve Bank of India, Mumbai, and
Governor, Andhra Pradesh, Hyderabad

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C—
Printed at:


To
my Students
for their inspiration

and
my Wife, Meera Mathur,
and my Daughters,
Archana Mathur
and
Kartika Mathur
for their sustained support



FOREWORD
Financial Management is critical to the succes of any organization. It is all the more so in the case of business
organizations, since almost all decisions taken have financial implications. It becomes, therefore, imperative
for all executives in a business organization to acquire a fairly good knowledge of the fundamental principles
of financial management and control.
Several books by Indian and foreign authors on the subject are available in the market. However, not all
of them are reader-friendly. Dr. Satish B. Mathur’s ‘Financial Management : Theory and Practice’ is
an exception. It is written in a conversational style. The narrative is lucid. Difficult and complex topics like
analysis and interpretation of financial statements, management and control of working capital, classification
and control of costs and cost-volume-profit analysis are presented in a manner that readers may go through
them with ease and sustained interest. In writing the book, the author has brought to bear on it his personal
experience as a senior executive with the State Bank of India for almost three decades. As a senior faculty at
the Indian Institute of Management, Lucknow, he knows what the requirements of students are.
I congratulate Dr. Mathur on his endeavour to produce a book covering the basic and essential aspects of
financial management and control. I am sure that the book will be widely used by students and faculty in
academic institutions as well as practising executives in industry and financial institutions.

(C. Rangarajan)

PREFACE
My friends, colleagues and well-wishers, in banks, industries and academia, and the top and senior executives
of banks and industries, participating in my Management Development Programmes (MDPs), and the PGP
students at the Indian Institute of Management, Lucknow, have been persuading me, to venture into writing
a comprehensive book on ‘Financial Management’, in the Indian context and conditions, citing suitable
illustrative live cases and examples, drawn from Indian experiences. They were, perhaps, thinking that, with
my vast and varied experience as a professional banker with the State Bank of India for around three decades,
in several senior positions, I may be able to do full justice to the subject.
In fact, their such a high opinion of, and expectation from me, had been more a deterrent, rather than
a facilitating factor, in my daring to take up such a demanding endeavour on my part. Besides, my varied
experience and widespread knowledge in the area had made me feel that the task was rather too stupendous,
difficult and demanding, even to make a humble beginning in this direction. But then, it took me long precious
time to realise that howsoever long and difficult a journey may be, it can be completed only after taking the first
step; that is, when a small beginning is made. Thus, the hard and hefty, concerted and concentrated efforts,
made in the right direction, and in right earnest, have made it possible for me to place the book, my humble
work, before you.
A book, like one’s own baby, is invariably the most beloved and beautiful one to its author. But then, the
real judges are, definitely and decidedly, the readers themselves. And, if they would think that the book has
presented the difficult and dull subject like ‘Financial Management’ in a quite easy-to-understand, interesting
and entertaining manner, I would think that my sincere endeavour was worth the effort. And, if the readers,
the students (of B.Com. and M.Com., MBA and PGP, degrees and diplomas), the Chartered Accountants, the
professional and practising bankers and industrialists, experience that, while reading the book, they tend
to feel as if the author had personally been talking to them, instead, on a one-to-one basis, I would sincerely
thank them all, and think that my sincere and strenuous efforts have been amply rewarded. I sincerely feel
that even the practising professionals of commercial banks and industries may find the book quite relevant for
reference and refreshing purposes.
A summary, containing the essence of each Chapter at its end, may be found very useful and handy for the
students at the time of their examination. Even the Professors, teaching the subject, may find the synopsis
immensely useful for preparing the required transparencies or slides on Power-Point Software, for use in

their lecture sessions. I earnestly solicit valuable suggestions from my worthy readers, for bringing in further
improvements in the next edition of the book.

Satish B. Mathur



ACKNOWLEDGEMENTS

At the very outset, I must thank my friends and colleagues in banks and academia, and the top and senior
executives of industries and banks, who participated in my Management Development Programmes (MDPs),
and the PGP students at the Indian Institute of Management, Lucknow, for their persistent persuasion and
encouragement, which made it possible for me to write the book on the subject.
I am immensely grateful to Meera Mathur, my wife, for her self-less sacrifice and support, and valuable
views, from time to time. My hearty gratitude is due to my lovely dear daughters – Archana Mathur and
Kartika Mathur, for their free and frank opinion, and constructive suggestions, which have gone a long way
in making the book so very reader-friendly, lucid and easy-to-understand, even by non-experts and non-finance
executives, in the business and industry. I am greatful to the publisher for timely publication this book.
Satish B. Mathur



CONTENTS
Foreword by Dr. C. Rangarajan.............................................................................................................................vii
Preface......................................................................................................................................................................ix
Acknowledgements..................................................................................................................................................xi

Part I:  FINANCIAL ANALYSIS

1. Financial Management and Control: An Overview

3–12

Introduction..................................................................................................................................................4

Facets of Financial Management................................................................................................................4

Historical Perspective..................................................................................................................................5

Deep Depression of the 1930s.....................................................................................................................6

Financial Management as a Distinct Discipline........................................................................................6

Vital Functions of Financial Management.................................................................................................7

Roles and Responsibilities of Internal Auditors.........................................................................................8

Summary....................................................................................................................................................10

Review Questions........................................................................................................................................11



2. Financial Statements

13–26

Introduction................................................................................................................................................14

Components of Financial Statements.......................................................................................................14

Basic Concepts and Conventions..............................................................................................................16

Basic Concepts Pertaining to ‘Balance Sheet’..........................................................................................16

Basic Concepts Pertaining to ‘Profit and Loss Account’ or ‘Income Statement’ .................................... 18

Format of Balance Sheet...........................................................................................................................20

Interpretation of Balance Sheet ...............................................................................................................21

Summary....................................................................................................................................................23

Review Questions........................................................................................................................................25

3.Balance Sheet

27–58

Introduction ...............................................................................................................................................28

Liabilities (Sources of Funds) ...................................................................................................................28


xiv

FINANCIAL MANAGEMENT: THEORY AND PRACTICE

Share Capital.............................................................................................................................................28

Equity Share (Ordinary Share) Capital...................................................................................................28

Some Terminologies...................................................................................................................................28

Some Other Terminologies........................................................................................................................31

Issuing of Shares........................................................................................................................................33

Preference Share Capital...........................................................................................................................34

Types of Preference Shares.......................................................................................................................35

Reserves and Surplus................................................................................................................................37

Secured Loans............................................................................................................................................39

Types of Secured Loans.............................................................................................................................40

Equitable Mortgage...................................................................................................................................45

Unsecured Loans........................................................................................................................................46

Current Liabilities and Provisions............................................................................................................47

Fixed Assets...............................................................................................................................................48
Investments................................................................................................................................................48

Current Assets...........................................................................................................................................49

Miscellaneous Expenses and Losses.........................................................................................................51

Summary....................................................................................................................................................51

Review Questions........................................................................................................................................56

Practise Problems.......................................................................................................................................57

4.Profit and Loss Account

59–74

Introduction................................................................................................................................................60

Items Reported in Profit and Loss Account..............................................................................................60

Profit and Loss Appropriation Account....................................................................................................64

Cash Profit..................................................................................................................................................65

Summary....................................................................................................................................................66

Review Questions........................................................................................................................................67

Appendix 4.1: Economic Value Added (EVA)...........................................................................................68



5. Evaluation of Financial Performance through Ratio Analysis Techniques

75–82

Introduction................................................................................................................................................76

Reclassification of Assets and Liabilities.................................................................................................76

Computation of Ratios...............................................................................................................................78

Analysis and Interpretation of the Ratios................................................................................................79

Review Questions........................................................................................................................................82

6.Evaluation of Financial Performance through Ratio Analysis Techniques:
Case Studies with Suggested Approaches

83–108

Introduction................................................................................................................................................84

Case Study—I: Light Motor Vehicles Limited..........................................................................................85

Case Study—II: Videsh Vyapar Nigam Limited......................................................................................98


CONTENTS

7.Sources and Application (Uses) of Funds Statements

xv

109–128

Introduction..............................................................................................................................................110

Components of Sources and Application of Funds.................................................................................110

Rationale behind Excluding Cash...........................................................................................................111

Case Studies with Suggested Approaches..............................................................................................112

Case Study I: Rashtriya Chemicals Limited (RCL)................................................................................113

Case Study II: Reliable Automobiles Ltd. (RAL) ...................................................................................119

Case Study III: Puja Paints Ltd. (PPL)..................................................................................................122

Summary..................................................................................................................................................125

Review Questions......................................................................................................................................125

Practise Problems.....................................................................................................................................125

Part II:  FUND-BASED WORKING CAPITAL MANAGEMENT AND CONTROL
8.Working Capital Management and Control: An Overview

131–138

Introduction..............................................................................................................................................132

Working Capital Management................................................................................................................132

Operating Cycle Approach.......................................................................................................................132

Importance of Working Capital Management........................................................................................132

Assessment of Working Capital Requirements and Formulation of Working Capital Policies.......... 133

Sources of Working Capital Financing (Short-Term and Long-Term Sources of Funds).................... 134

Working Capital Financing by Banks.....................................................................................................134

Management of Credit Risks...................................................................................................................134

Effective Supervision and Follow-Up of Advances.................................................................................134

Non-Fund Based Working Capital Finance...........................................................................................135
Conclusion................................................................................................................................................135

Summary..................................................................................................................................................135

Review Questions......................................................................................................................................136

9.Working Capital Policy

139–154

Introduction..............................................................................................................................................140

Components of Working Capital Management......................................................................................140

Working Capital Management vs Project Management........................................................................141

Special Features of Current Assets........................................................................................................141

Synergy of Team Spirit............................................................................................................................142

Factors Affecting Working Capital Requirements.................................................................................143

Optimal Level of Current Assets.............................................................................................................145

Working Capital Financing Policy..........................................................................................................146

Operating Cycle and Cash Cycle.............................................................................................................149

Time-Series Analysis vs Cross-Section Analysis....................................................................................150

Summary..................................................................................................................................................151

Review Questions......................................................................................................................................152

Practise Problems.....................................................................................................................................154


xvi

FINANCIAL MANAGEMENT: THEORY AND PRACTICE

10. Working Capital Management and Control: Operating Cycle Approach

155–166

Introduction..............................................................................................................................................156

Operating Cycle Analysis........................................................................................................................156

Weighted Operating Cycle Analysis.......................................................................................................159

Working Capital Leverage.......................................................................................................................162

Summary..................................................................................................................................................164

Review Questions......................................................................................................................................165


Practise Problems.....................................................................................................................................165

11. Cash Management

167–204

Introduction..............................................................................................................................................168

Cash Budgeting........................................................................................................................................168

A Suggested Approach to Overcome Cash Shortages............................................................................170

Long-Term Cash Forecasting..................................................................................................................172

Periodical Reports and Statements for Control of Cash........................................................................173

Effective Management and Control of Sundry Debtors.........................................................................173

Current Account vs Cash Credit Account...............................................................................................175

Depositing Margin Money in Cash Credit Account...............................................................................176

Management and Control of Payments..................................................................................................176

Playing the Float......................................................................................................................................178

Investment of Surplus Funds..................................................................................................................179

Units of the Unit Trust of India: 1964 Scheme......................................................................................180

Models of Cash Management..................................................................................................................185

Case Study–I: TDR is not the Best..........................................................................................................190

Case Study–II: Turns Tricky...................................................................................................................192

Case Study–III: Investing Surplus Funds: Where and Why?................................................................. 194

Summary..................................................................................................................................................197

Review Questions......................................................................................................................................201

Practise Problems.....................................................................................................................................202

12. Credit Management

205–235

Introduction..............................................................................................................................................206

Credit Policy.............................................................................................................................................206

Steps and Strategies for Keeping Sundry Debtors Low........................................................................207

A General Pattern of Follow-up Measures.............................................................................................208

Streamlined Enquiry Systems................................................................................................................209

Phone Yourself to Find Yourself.............................................................................................................210

Main Causes of High Sundry Debtors....................................................................................................210

Ramifications of High Sundry Debtors...................................................................................................212

Formulation of Credit Policy...................................................................................................................212

Cash Discount..........................................................................................................................................213

Management Control System (MCS) and Sundry Debtors....................................................................214
Decision-Making......................................................................................................................................217


CONTENTS

xvii

Parameters of Credit Policy....................................................................................................................220
Decision-Making for Granting Credit.....................................................................................................227
Management of Sundry Debtors (Bills Receivable or Accounts Receivable) in India.......................... 229
Some Suggestions for Improvement.......................................................................................................230
Summary..................................................................................................................................................231
Review Questions......................................................................................................................................234
Practise Problems.....................................................................................................................................234
Appendix 12.1...........................................................................................................................................236
Appendix 12.2...........................................................................................................................................237
Appendix 12.3...........................................................................................................................................238
Appendix 12.4...........................................................................................................................................240
Appendix 12.5...........................................................................................................................................241

13. Inventory Management

243–280

Introduction..............................................................................................................................................244

Components and Importance of Inventories..........................................................................................244

Economic order Quantity (EOQ).............................................................................................................244

Basic Economic Order Quantity (EOQ) Model.......................................................................................246

EOQ Formula vs. Trial and Error Method.............................................................................................246

Derivation of EOQ Formula....................................................................................................................250

Economic Order Quantity (EOQ) and Optimal Order Quantity (OOQ)............................................... 251

Economic Order Quantity (EOQ) and Inflation.....................................................................................255

Components of Inventory-Carrying Costs..............................................................................................256

Lead Time.................................................................................................................................................257

Order Point...............................................................................................................................................257

Safety Stock..............................................................................................................................................258

Other Variable Factors Affecting EOQ...................................................................................................259

ABC Analysis (or VED Analysis)............................................................................................................260

Categorization of Items for ABC Analysis..............................................................................................262

Rationale Behind Some Other Alternative Categorization...................................................................265

Inventory Control through Ratio Analysis.............................................................................................266

Just-in-Time (JIT) System vs. Just-in-Case (JIC) System....................................................................267

Towards Evolving an Effective System for Inventory Management, Monitoring and Control........... 268

Strategies to Achieve Success in Inventory Management and Control................................................ 269
Rationality................................................................................................................................................269
Flexibility.................................................................................................................................................270

Inventory Management in India.............................................................................................................270

Room for Improvement – Some Suggestions..........................................................................................271

Summary..................................................................................................................................................272

Review Questions......................................................................................................................................275

Practise Problems.....................................................................................................................................276


xviii

FINANCIAL MANAGEMENT: THEORY AND PRACTICE

14. Financing of Working Capital Requirements

281–302

Introduction..............................................................................................................................................282

Short-Term Sources of Funds..................................................................................................................282
Accruals....................................................................................................................................................282

Trade Credits...........................................................................................................................................282

Short-Term Loans from Financial Institutions......................................................................................284

Rights Debentures...................................................................................................................................285
Factoring..................................................................................................................................................285

Long-Term Sources of Funds...................................................................................................................288

Retained Earnings...................................................................................................................................289

Term Loans..............................................................................................................................................289

Case Study–I: Down the Shutter.............................................................................................................292

Case Study–II: An Innocent Victim.........................................................................................................296

Summary..................................................................................................................................................297

Review Questions......................................................................................................................................299

Part III:  WORKING CAPITAL FINANCE BY BANKS
15. Working Capital Finance by Banks

305–334

Historical Perspective..............................................................................................................................306
Assessment of Working Capital Requirements by Banks.....................................................................306

Assessment of Working Capital Finance to Non-SSI Sector................................................................. 307
Financial Follow-up Reports (FFRs) for Working Capital Finance...................................................... 308
Some Modifications in the Categorization of the Current Assets (CAs)
and Current Liabilities (CLs)..................................................................................................................308
Commitment Charges..............................................................................................................................309
Verification of the Levels of Inventories, Receivables and Sundry Creditors..................................... 309
Bifurcation of Working Capital (WC) Limit...........................................................................................310
Rationale Behind Bifurcation of Working Capital Limit into
Cash Credit Component (CCC) and Working Capital Demand Loan (WCDL).................................... 313
Bifurcation of Approved Bank Finance (ABF) of ` 2 Crore and
above but below Rupees 10 Crore...........................................................................................................313
Assessment of Working Capital Requirements of SSI Sector
(As Per Nayak Committee, W.E.F. June 1993)......................................................................................315
Summary..................................................................................................................................................318
Review Questions......................................................................................................................................320
Practise Problems.....................................................................................................................................321
Appendix 15.1...........................................................................................................................................322
Appendix 15.2...........................................................................................................................................324
Appendix 15.3...........................................................................................................................................325
Appendix 15.4...........................................................................................................................................327
Appendix 15.5...........................................................................................................................................328
Appendix 15.6...........................................................................................................................................330
Appendix 15.7...........................................................................................................................................332


CONTENTS

16. Management of Credit Risks by Banks

xix

335–356

Introduction..............................................................................................................................................336

Historical Perspective..............................................................................................................................336

Credit Risk Assessment (CRA) System..................................................................................................338

Concept of Credit Risk Assessment (CRA).............................................................................................339

Credit Risk Assessment (CRA) Model....................................................................................................339

Financial Risks Assessment....................................................................................................................339

Overall Financial Risks Assessment......................................................................................................340

Industrial Risks.......................................................................................................................................342

Managerial Risks.....................................................................................................................................342

Overall Credit Risks Assessment (CRA)................................................................................................343

Overall Score (A Suggested Pattern)......................................................................................................344

Pricing Mechanism of Advances.............................................................................................................344

Minimum Cut-Off Point...........................................................................................................................345

Summary..................................................................................................................................................345

Review Questions......................................................................................................................................347

Appendix 16.1...........................................................................................................................................349

Appendix 16.2...........................................................................................................................................353

17. Disbursement and Follow-up of Working Capital Finance by Banks

357–370

Introduction..............................................................................................................................................358

Project Appraisal......................................................................................................................................358

Assessment of Working Capital Requirements......................................................................................359

Phased Disbursement of Loans...............................................................................................................361

Supervision and Follow-up of Advances and Performance Monitoring of Units.................................. 362

Case Study–I.............................................................................................................................................362

Case Study–II...........................................................................................................................................363

Case Study–III..........................................................................................................................................363

Case Study–IV..........................................................................................................................................364

Case Study–V...........................................................................................................................................364

Summary..................................................................................................................................................368

Review Questions......................................................................................................................................369

Part IV:  NON-FUND BASED WORKING CAPITAL FINANCING
18. Letters of Credit

373–398

Introduction..............................................................................................................................................374

Why Non-Fund Based Financing?..........................................................................................................374

Why Letters of Credit?.............................................................................................................................374

What is Letter of Credit (L/C)?................................................................................................................375

How are Letters of Credit Issued?..........................................................................................................375

Amendments to the L/C...........................................................................................................................375

Payment Under Reserve..........................................................................................................................376


xx

FINANCIAL MANAGEMENT: THEORY AND PRACTICE

Case Study–I: Japson International vs. State Bank of India................................................................ 376
Exhibit 18.1..............................................................................................................................................382
Calculation of Due Date of a Bill of Exchange made Payable after the
Specified Number of Days or Months......................................................................................................385
Presentation of Time Bills for Acceptance and Payment........................................................................387
Mode of Acceptance of the Time Bill........................................................................................................387
Types of Letters of Credit.........................................................................................................................387
Case Study–II: Beware, Be Wary.............................................................................................................390
Summary..................................................................................................................................................394
Review Questions......................................................................................................................................396
Practise Problems.....................................................................................................................................397

19. Bank Guarantees

399–432

Introduction..............................................................................................................................................400

What is a Bank Guarantee?....................................................................................................................400

Purposes of Financial Bank Guarantees................................................................................................400

Performance Bank Guarantees...............................................................................................................402

Restrictions Imposed by The Reserve Bank of India
(RBI) on Issuance of Performance Bank Guarantees............................................................................403

Validity Period of Bank Guarantees.......................................................................................................404

Legal Implications/Ramifications of Performance Bank Guarantees................................................... 405

Case Studies.............................................................................................................................................407

Case Study–I: Carpets and Crafts Commission......................................................................................407

Exhibit 19.1..............................................................................................................................................409

Enclosure to Exhibit 19.1.........................................................................................................................410

Exhibit 19.2..............................................................................................................................................411

Exhibit 19.3..............................................................................................................................................412

Enclosure to Exhibit 19.3.........................................................................................................................413

Exhibit 19.4..............................................................................................................................................414

Exhibit 19.5..............................................................................................................................................415

Enclosure to Exhibit 19.5.........................................................................................................................416

Exhibit 19.6..............................................................................................................................................417

A Simplified Version of Case Study-I......................................................................................................422

Exhibit 19.7..............................................................................................................................................424

Exhibit 19.8..............................................................................................................................................425

Exhibit 19.9..............................................................................................................................................426

Case Study–II...........................................................................................................................................427

Summary..................................................................................................................................................429

Review Questions......................................................................................................................................431

Practise Problems.....................................................................................................................................432


CONTENTS

xxi

Part V:  SOME OTHER SHORT-TERM FINANCING
20. Export Finance (Short-Term)

435–444

Introduction..............................................................................................................................................436

What is Export Financing?......................................................................................................................436

Assessment of Financial Requirements of Export Finance...................................................................436

Shipment Stage........................................................................................................................................438

Post-Shipment Finance...........................................................................................................................438

How is Pre-Shipment Finance Repaid?..................................................................................................439

Advance Against Export Bills Sent for Collection.................................................................................439

Export Finance in Foreign Currency......................................................................................................440

Advance Against Duty Drawback and Cash Subsidy............................................................................440

Export Credit Guarantee Corporation (ECGC)......................................................................................441

Exhibit 20.1..............................................................................................................................................441

Exhibit 20.2..............................................................................................................................................442

Summary..................................................................................................................................................442

Review Questions......................................................................................................................................443

21. Short-Term (Working Capital) Financing of Information Technology (IT)
and Software Industry

445–454

Introduction..............................................................................................................................................446

Salient Features of Software Industries.................................................................................................446

Indian Advantages and Disadvantages..................................................................................................447

Critical Success Factors in Software Industry.......................................................................................447

Key Risk Factors......................................................................................................................................448

Facilitating Factors for Fresh Exposures...............................................................................................449

Working Capital Finance for Information Technology and

Software Industries [Reserve Bank of India (RBI) Guidelines]............................................................ 450

Operational Guidelines for Extending Working

Capital Finance to IT and Software Industries.....................................................................................451

Summary..................................................................................................................................................453

Review Questions......................................................................................................................................454

Part VI:  PROFITABILITY AND COST CONTROL
22. Contribution Analysis and Break-Even Point (BEP) or

Cost-Volume-Profit (CVP) Analysis

457–470

Introduction..............................................................................................................................................458

Fixed Costs and Variable Costs..............................................................................................................458

Algebraic Presentation of Break-Even-Point.........................................................................................458

Arithmetical Presentation of BEP..........................................................................................................460

Various Expressions of BEP....................................................................................................................461

Some Other Uses of Contribution Analysis............................................................................................465


xxii




FINANCIAL MANAGEMENT: THEORY AND PRACTICE

Summary..................................................................................................................................................466
Review Questions......................................................................................................................................467
Practise Problems.....................................................................................................................................468

23. Cost Management and Control – Steps and Strategies

471–480

Introduction..............................................................................................................................................472

Cost Control Drivers................................................................................................................................472

Value Chain..............................................................................................................................................472

Total Cost Management (TCM) and Business Process Re-Engineering (BPR).................................... 472

TCM and TQM.........................................................................................................................................472

Cost Control..............................................................................................................................................472

Valuing the Vendors................................................................................................................................473

Compare and Compete with the Best.....................................................................................................473

Flexible Manufacturing System..............................................................................................................473

Distribution and Servicing Channel.......................................................................................................474

Use of Infotech and IT.............................................................................................................................474

Cutting Non-Manufacturing overheads..................................................................................................474

Adopt Some Innovative Strategies..........................................................................................................475

Cut Cost of Human Capital.....................................................................................................................475

Adopt Activity-Based Costing (ABC)......................................................................................................476

Some Key Factors for Success.................................................................................................................476

Total Cost Management in India............................................................................................................476

Summary..................................................................................................................................................477

Review Questions......................................................................................................................................479

Part VII:  PLANNING, BUDGETING AND CONTROL
24. Corporate Planning, Budgeting and Control

483–502

Introduction..............................................................................................................................................484

Long Range Plan (LRP) vs Short Range Plan (SRP).............................................................................484

Performance Budgeting...........................................................................................................................484

Steps and Stages Involved in the Performance Budgeting Exercise.................................................... 484

Budgeting in a Manufacturing Company...............................................................................................485

Per Cent of Sales Method........................................................................................................................486

Combination Method...............................................................................................................................487

Pro Forma Balance Sheet........................................................................................................................488

Budgeting Process in a Manufacturing Company..................................................................................490

Incremental Budgeting vs Zero Base Budgeting (ZBB).........................................................................495

Inter-Departmental Coordination...........................................................................................................495

Performance Monitoring and Review.....................................................................................................496

Summary..................................................................................................................................................498

Review Questions......................................................................................................................................500

Practise Problems.....................................................................................................................................501


CONTENTS

xxiii

Part VIII:  INVESTMENT ANALYSIS
25. Time Value of Money

505–518

Introduction..............................................................................................................................................506

Time Value of Money...............................................................................................................................506

Net Present Value (NPV)........................................................................................................................508

Future Value of an Annuity....................................................................................................................509

Present Value of an Annuity...................................................................................................................510

Compounding for Less than One Year Period........................................................................................512

Discounting for Less than One Year Period...........................................................................................513

Continuous Compounding and Discounting...........................................................................................513

Summary..................................................................................................................................................514

Review Questions......................................................................................................................................516

Practise Problems.....................................................................................................................................516

26. Capital Budgeting (Capital Investment Decisions)

519–534

Introduction..............................................................................................................................................520

What is Capital Budgeting?....................................................................................................................520

Capital Budgeting: Why Considered So Important?..............................................................................520

Phases of Capital Budgeting Process......................................................................................................520

How to Avoid Time Overruns?................................................................................................................521

Performance Review................................................................................................................................522

Classification of Projects..........................................................................................................................522

Criteria of Investment Evaluation..........................................................................................................523

Some General Guiding Principles...........................................................................................................530

Summary..................................................................................................................................................530

Review Questions......................................................................................................................................533

27. Leasing, Hire-Purchase, and Project Financing
















535–560

Introduction to leasing.............................................................................................................................536
Payment Schedule of Lease Rentals.......................................................................................................536
Types of Lease..........................................................................................................................................536
Rationale behind Leasing........................................................................................................................541
Some Unreal Rationale of Leasing..........................................................................................................542
Legal Aspects of Leasing.........................................................................................................................542
Responsibilities of the Lessee..................................................................................................................543
Brief Contents of a Lease Agreement.....................................................................................................543
Provisions of Sales Tax Pertaining to Lease..........................................................................................544
Some Relevant Provisions of Income Tax...............................................................................................544
Accounting Aspects of Leasing in India..................................................................................................544
Hire Purchase...........................................................................................................................................546
Salient Features of Hire Purchase..........................................................................................................547
Leasing and Hire Purchase – A Comparison.........................................................................................549
Instalment Sale and Hire Purchase – A Comparison............................................................................549


xxiv








FINANCIAL MANAGEMENT: THEORY AND PRACTICE

Project Financing.....................................................................................................................................550
Salient Features of Project Financing....................................................................................................550

Project Financing Mechanisms...............................................................................................................551
Managing Financial Risks and their Allocations...................................................................................552
Summary..................................................................................................................................................553
Review Questions......................................................................................................................................557
Practise Problems.....................................................................................................................................559

Part IX:  DIVIDEND POLICY AND DECISION
28. Dividend Policy and Firm Value

563–582

Introduction..............................................................................................................................................564

Models in Which Investment and Dividend Decisions are Related...................................................... 564

Traditional Position.................................................................................................................................567

Miller and Modigliani (MM) Position: ‘Dividend Irrelevance’ Theorem............................................... 568

Radical Position.......................................................................................................................................574

Concluding Remarks................................................................................................................................574

Summary..................................................................................................................................................575

Review Questions......................................................................................................................................579

Problems Solved.......................................................................................................................................580

Practise Problems.....................................................................................................................................582

29. Dividend Decision

583–618

Introduction..............................................................................................................................................584

Why Do the Companies Pay the Dividends?..........................................................................................584

Dimensions of Dividend Policy................................................................................................................586

Dividend Policy: Payout Ratio.................................................................................................................587

Dividend Policy: Stability........................................................................................................................588

Dividend as a Residual Payment............................................................................................................589

Corporate Dividend Behaviour...............................................................................................................590

Legal and Procedural Aspects.................................................................................................................591

Bonus Shares and Stock Splits...............................................................................................................593

Share Buybacks........................................................................................................................................598

Dividend Policies in Practice: Some Typical Types of Policies.............................................................. 603

Summary..................................................................................................................................................603

Review Questions......................................................................................................................................613

Solved Problems.......................................................................................................................................615

Practise Problems.....................................................................................................................................616

Part X:  MERGERS, ACQUISITIONS AND RESTRUCTURING
30. Mergers, Acquisitions and Restructuring

621–644

Introduction..............................................................................................................................................622

Rationale Behind Mergers.......................................................................................................................622