Marketing Management

UNIT 19 FINANCIAL MANAGEMENT

Structure
19.0 Objectives
19.1 Introduction
19.2 Definition and Functions of Financial Management
19.3 Objectives of Financial Management
19.3.1 Profit Maximisation Approach
19.3.2 Wealth Maximisation Approach
19.3.3 Profit Maximisation Vs. Wealth Maximisation
19.4 Sources of Finance
19.4.1 Shares
19.4.2 Debentures
19.4.3 Venture Capital
19.4.4 Lease Financing
19.5 Security Market
19.5.1 Primary Market
19.5.2 Secondary Market
19.6 Role of SEBI
19.7 Let Us Sum Up
19.8 Key Words
19.9 Answers to Check Your Progress
19.10 Terminal Questions

19.0 OBJECTIVES
After studying this unit, you should be able to:
describe the concept of financial management and its functions
discuss the objectives of financial management
explain various sources of finance
discuss the merits and demerits of equity shares and preference shares
explain the various types, merits and demerits of debentures
describe the features, advantages and disadvantages of venture capital
discuss the features, advantages and disadvantages of lease financing
describe about securities markets, i.e. primary and secondary market; and
state the role of SEBI

19.1 INTRODUCTION
You must be aware that the major activities involved in a manufacturing
organisation may be : purchasing of raw materials, processing them with the
association of labour, machinery etc., manufacturing the final product and
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Functional Areas of marketing the finished product. Thus, the finance, production and marketing are
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important aspects of business. Finance plays very crucial role in the business.
The production and marketing activities are related to the finance. It is essential
to take the financial decisions at the right time and in the most rational way. The
success of the business may depend on taking right financial decision. Thus,
finance is considered as life-blood of business. In this unit, you will learn the
concept, functions and objectives of financial management. You will further
learn the sources of finance i.e. equity shares, debentures, venture capital and
lease financing. You will be also acquainted with the security market i.e. primary
and secondary market and the role of SEBI.

19.2 DEFINITION AND FUNCTIONS OF

FINANCIAL MANAGEMENT
Financial management is concerned with planning and controlling of resources
of Firms. According to Paul. G. Hasings, “Finance is the management of the
monetary affairs of a company. It includes determining what has to be paid for
raising the money on the best terms available and devoting the available resources
to best uses.”

Kenneth Midgley and Ronald Burns stated that “Financing is the process of
organising the flow of funds so that a business can carry out its objectives in the
most efficient manner and meet its obligations as they fall due.”

From the above definitions of finance, it can be concluded that the term business
finance mainly involves : raising of funds and their effective utilisation keeping
in view the overall objectives of the firm. The management makes use of the
various financial techniques and devices for the most effective and efficient
way of financing. Let us now discuss the various functions and objectives of
Financial Management.

Functions of Financial Management

The functions of financial management are as follows :
1) Estimation of capital requirements: An estimation regarding the capital
requirements of the company has to be made in the most appropriate way.
The estimation depends on costs and profits as well as future programmes
and policies of the organisation. Estimations have to be made in an adequate
manner to facilitate earning capacity of the organisation.
2) Determination of capital composition: The capital structure has to be
decided after making estimation of capital. Short- term and long- term debt
equity analysis may be done for this purpose. This depends on the proportion
of equity capital and the additional fund to be raised.
3) Choice of sources of funds: The company has many sources for raising
funds. These sources are :
a) Issue of shares and debentures
b) Loans to be taken from banks and financial institutions
c) Public deposits to be drawn in the form of bonds.

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4) Investment of funds: The finance manager has to decide to allocate funds Financial Management
into profitable ventures. This facilitates safety and regular returns on
investment.
5) Disposal of surplus: The finance manager has to decide about the disposal
of surplus. The disposal of surplus may be decided in the following ways :
a) Dividend declaration – The manager may decide about the rate of
dividends and other benefits like bonus.
b) Retained profits - The amount of retained profit may be decided by
the manager. The decision may depend on the expansional, innovational
diversification etc., as well as the plans of the company.
6) Management of Cash: The cash management may be decided by the
finance manager. Cash may be required for 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: In addition to planning, procuring and utilisation of
funds, the finance manager has to exercise control over finances. The
financial control may be done through ratio analysis, financial forecasting,
cost and profit control, etc.

19.3 OBJECTIVES OF FINANCIAL

MANAGEMENT
As you have learnt that the Financial Management is concerned with the efficient
use of capital funds. It evaluates how are funds procured and used. Financial
Management includes taking decision in three inter related areas. These are :
investment, financing and dividend policy. The decisions are taken by the finance
manager considering the objectives of the firm. The objectives provide a
framework for optimal financial decision of the company. There are two
approaches for this purpose.
i) Profit Maximisation Approach
ii) Wealth Maximisation Approach
Let us learn them in detail.

19.3.1 Profit Maximisation Approach

According to this approach, actions that increase profits should be undertaken
and that decrease profits should be avoided. This approach focuses on
maximisation of profits and income of the company. The company should decide
those projects which are profitable. The projects which are not profitable should
be rejected. The behavior of a Company is analysed in terms of profit
maximisation in economic theory. In the profit maximisation, a firm either
produces maximum output for a minimum input, or uses minimum input for a
given output. Therefore, the efficiency is the most significant aspect for the
company. Profit is a test of economic efficiency which provides a yardstick for
evaluating the economic performance.

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Functional Areas of There are several criticisms of profit maximisation approach. The main technical
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flaws are ambiguity, timing of benefits and quality of benefits. These are discussed
as below:

a) Ambiguity : There is an ambiguity in the concept of profit. Different

scholars have interpreted this concept differently. The profit may be total
profit before tax or after tax or profitability rate. The rate of profitability
may be determined in relation to share capital; owner’s funds, total capital
employed or sales. The profit does not indicate about the short-term and
long-term profits. The short-term profit may not be the same as those in the
long term. For example, a firm may maximise its short-term profit by
avoiding current expenditures on maintenance of a machine. In lack of
maintenance, the machine may not be able to operate for manufacturing
the products. As a result, the firm will have to make huge investment to
replace the machine. In this way, the profit maximisation suffers in the long
run due to maximisation of short-term profit.

b) Timing of benefit : The profit maximisation approach ignores the

differences in the time pattern of the benefits received. It does not consider
the difference between returns received in different time periods. It treats
all benefits irrespective of the timings equally. This is not true in actual
practice. The benefits in early years should be valued more than benefits in
later years.

c) Quality of benefits : This approach ignores the quality aspect of benefits in

financial action of the company. The quality refers to the degree of certainty
with which benefits can be expected. The more certain the expected return,
the higher is the quality of the benefits. An uncertain and fluctuating return
may lead to high risk for stakeholders.

The above criticisms show that the profit maximisation approach may not be
only decider for financing, investing and dividend decision of the company. It
does not consider the risk and time value of money.

19.3.2 Wealth Maximisation Approach

This approach is also known as value maximisation or Net Present Worth
maximisation. It tries to remove the technical limitations of profit maximisation
approach.
Wealth maximisation means maximising the Net Present Value (or wealth) of a
course of action. The net present value of a course of action is the difference
between the present value of its benefits and the present value of its costs. A
financial action which leads to positive Net Present Value may create wealth,
this should be acceptable by the company. A financial action which leads to
negative NPV and does not create wealth should not be accepted. Thus, the
project which has the potential of highest NPV should be decided.
The objective of wealth maximisation takes into account the timing and risk of
expected benefits. These problems are taken care by selecting an appropriate
rate for discounting the expected flow of future benefits. You should understand
that the benefits are measured in terms of cash flows. The flow of cash is important
in investment and financial decisions, not the accounting profits. The wealth
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created by a Company through its actions is reflected in the market value of
company’s shares. The value of the company’s share is represented by the market Financial Management
price. The market price of the company’s share reflects sound financial decision
of the company. It shows the performance indicator of the company.

There are three requirements of a suitable operational objective of financial

courses of action. These are : exactness, quality of benefits and the time value of
money. Let us learn them in detail.

1) Exactness : The value of an asset should be determined in terms of returns.

The worth of a course of action should be valued in terms of the returns
less the cost of undertaking the particular course of action. The important
factor in computing the value of a financial course of action is the exactness
in computing the benefits associated with the course of action. This approach
focuses on cash flows and not on accounting profit. The computation of
cash inflows and cash outflows should be precise.

2) Quality, benefit and time value of money : The wealth maximisation

considers both the quality and quantity dimensions of benefits. It also
considers the time value of money. You have understood from earlier
discussion that the quality of benefits refers to certainty with which benefits
are received in future.

The more certain the expected cash inflows, the better the quality of benefits
and higher the value. If the flows are less certain, the quality would be less and
the value of benefits would be less. You should also understand that money has
time value. Therefore, the benefits received in earlier years should be valued
higher than benefits received later.

In order to deal with the uncertainty and timing dimensions of the benefits of
financial decision, the adjustments need to be made in the cash flow pattern.
The cash flow pattern should incorporate risk and make an allowance for
differences in the timing of benefits. Thus, Net Present Value maximisation
appears to be superior to the profit maximisation approach.

It involves a comparison of value of cost. Let us consider an action that has a

discounted value which reflects both time and risk. If this action exceeds cost,
it is said to create value. Such actions should be selected. Contrary to this, actions
with less value than cost, reduce wealth, such actions should be rejected.
Therefore, the Net Present Value Maximisation appears to be superior to the
profit maximisation.

19.3.3 Profit Maximisation Vs. Wealth Maximisation

One of the main objective of financial management has been profit maximisation
and wealth maximisation. Profit maximisation focuses on improving profitability,
maintaining the stability and reducing losses and inefficiencies.
1) Profit may be considered in two senses :
1) Profit maximisation for the owner; and
2) Profit maximisation for others.
Normally profit is linked with efficiency, therefore, it is the test of efficiency.
The limitation of this concept may be ambiguity which reflects different
interpretation from different persons. 31
Functional Areas of 2) Quality of profit – Usually, profit is calculated in rupees. The amount
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earned is known as profit. It ignores wastage, efficiency, employee’s skill,
employee’s turnover, product mix, manufacturing process, administrative
set-up etc., which may influence profit.

3) Timing of benefit - In inflationary conditions, the value of profit may

decrease. Therefore, the profits may not be comparable over a longer period
span.

4) Some economists argue that profit maximisation may result into unhealthy
trends. The unhealthy trend may be harmful to the society. It may lead to
exploitation, unhealthy competition and taking undue advantage of the
position.

Check Your Progress A

1) Define Financial management?
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2) What do you mean by Profit maximisation approach?

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3) What is Wealth Maximisation approach?

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19.4 SOURCES OF FINANCE

You have learnt the functions and objectives of financial management. The
finance is the backbone of the business. The finance is required for performing
the operations of the business. When the business is carried out in the company
form, there are different sources of finance for the company. The company has
to decide the sources of finance based on the financial requirement and the
position of the debt to the company.
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The finance may be raised through equity shares, debentures, venture capital Financial Management
and lease financing. Let us learn them in detail.

19.4.1 Shares
According to Companies Act 2013, “Share means a share in the share capital of
a company including stocks shares are considered as a type of security”. There
are two types of shares i.e. equity shares and preference shares. Let us learn
about both the types of shares.

Equity Shares

Equity shares are the most important source of raising long term capital by a
company. These shares represent the ownership of a company. The capital raised
by issue of equity shares is known as ownership capital or owner’s funds. Equity
share capital is a prerequisite to the creation of a company. Equity shareholders
do not get a fixed dividend. They are paid on the basis of earnings by the company.
They are also referred to ‘residual owners’. They receive the claim after all
other claims on the company’s income and assets have been settled. They enjoy
the reward and also bear the risk of ownership. The liability of equity shareholder
is limited to the extent of capital contributed by them in the company. They have
a right to participate in the management of the company through their right to
vote.

Merits

The important merits of raising funds through issuing equity shares are as follows:

i) Equity shares are suitable for those investors who are ready to take risk for
higher returns.
ii) Payment of dividend is not compulsory for equity shareholders. Therefore,
there is no burden on the company for payment of dividend to them.
iii) Equity capital is a permanent capital. It is repaid only at the time of
liquidation of a company. The claims are paid after all settlement. Therefore,
it works as cushion for creditors in case of winding-up of company.
iv) It provides credit worthiness to the company. It also provides confidence
to prospective loan providers.
v) Funds may be raised through equity issue without creating any charge on
the assets of the company. The assets of a company may not be required to
be mortgaged for the purpose of borrowings.
vi) The voting rights of equity shareholders facilitates democratic control over
management of the company.

Demerits
The demerits of equity shares are as follows :
A) To the Shareholders
1) Uncertainty about payment of dividend: The equity share-holders
get dividend only when the company is earning sufficient profits and
the Board of Directors declare dividend. In case of preference
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Functional Areas of shareholders, equity shareholders get dividend only after payment of
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dividend to the preference shareholders.

2) Speculative: There may be speculation on the prices of equity shares.

This may happen at the time of boom when company pays high
dividend.

3) Danger of over–capitalisation: If the management is not able to

predict long-term financial requirements, it may raise more funds than
required by issuing shares. This may lead to over-capitalisation. The
over-capitalisation results into low value of shares in the stock market.

4) Ownership in name only: The holder of equity shares becomes the

owner of the company. They have got voting rights. They manage
and control the company. This may be true theoretically. In fact, few
persons may control the voting rights and thus, they may manage the
company. Board of Directors take the decision to declare dividends.

5) Higher Risk: Equity shareholders take high degree of risk. In case of

losses, they do not get dividend. In case of winding-up of a company,
they are the last persons to get refund of the money which they have
invested. Equity shares actually swim and sink with the company.

B) To the Management
1) No trading on equity: It refers to the ability of a company to raise
funds through preference shares, debentures and bank loans, etc. The
company has to make payment at a fixed rate on the funds. When
profits are high, the equity shareholders get a higher rate of return.
The major part of the profit earned is paid to the equity shareholders.
This is done because borrowed funds carry only a fixed rate of interest.
The company may get advantage of trading on equity if a company
has only equity shares and does not have either preference shares,
debentures or loans.

2) Conflict of interests: You are aware that the equity shareholders carry
voting rights. Therefore, the groups are formed to corner the votes.
Such groups grab the control of the company. The conflict of interests
may develop which may be harmful for the smooth functioning of a
company.

7) Preference Shares

Preference shares refer to those shares which have certain special rights.
The dividend is payable on these shares before the equity shares. Capital
is repaid to preference shareholders before the return of equity capital in
case of winding-up of the company. Preference shareholders do not have
the voting rights. In case of non-payment of dividend, the preference
shareholders may claim the voting rights. The voting rights may be claimed
if dividends are not paid to cumulative preference shareholders for two
years or more and for non-cumulative preference shares for three years or
more.

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Merits Financial Management

The merits of the preference shares are as follow:

1) Appeal to Cautious Investors: There are investors, who want safety of

their capital. They want fixed and regular return. The preference shares
may be sold to such investors.

2) No Obligation: When the profits of the company are not sufficient, the
company may not pay dividend on preference shares. In case of cumulative
preference shares, the dividend may be postponed.

3) No Intervention: Preference shares have no voting rights. Therefore, they

are not able to intervene in the management of the company.

4) Trading on Equity: As you know that rate of dividend on preference shares

has been fixed. The benefits of trading on equity may be provided to the
equity shareholders when the profits of the company are high.

5) No Charge on Assets: As you know that preference shares do not create

any mortgage or charge on the assets of the company. The fixed assets of
the company may be utilised for raising the funds in future.

6) Flexibility: The redeemable preference shares may be issued by the

company for a fixed period. When the capital is not required for the business,
it can be repaid. The capital structure becomes elastic. The company does
not face the problem of over-capitalisation.
Demerits
The demerits of the preference shares are as follow:
1) Fixed Obligation: The company is bound to pay the dividend on preference
shares at a fixed rate. This is paid before the payment of dividend on
equity shares.

2) Limited Appeal: The risk taker investors may not invest in preference
shares. The investors who do not want to take risk may like to invest in
debentures and government securities. The company may provide high
rate of dividend to attract the investors.

3) Low Return: The fixed rate of dividend on preference shares may not be
attractive, when the profits of the company are high.

4) No Voting Rights: There are no voting rights to the preference shareholders.

As a result, they can not intervene in the management of the company.

Difference between Equity Share and Preference Share

You have learnt merits and demerits of equity shares and preference shares. Let
us now learn the difference between equity shares and preference shares which
are discussed below :

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Functional Areas of Difference between Equity Share and Preference Share
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Basics Equity share Preference share
Refund of Capital The payment to the equity The payment to the preference
share capital is made after the share capital is made before the
payment of preference share payment of the equity share
capital in case of winding-up capital in case of winding-up of
of the company. the company.
Right of Dividend Equity shares are paid The preference shares are paid
dividend after the payment of dividend before the payment of
dividend on preference dividend on Equity shares.
shares.
Rate of Dividend There is no fixed rate of There is a fixed rate of dividend.
dividend. The dividend is The dividend is prescribed on
decided by Board of the face of preference shares at
Directors every year and vary the fixed rate. For example, 9%
from time to time. preference share means rate of
dividend is 9%.
Right to Vote The right to vote has been The right to vote has not been
provided to equity provided to preference share-
shareholder. The equity holders in normal case. In
shareholders elect Director special case, they may be
for managing the company. provided right to vote.
Redemption Equity shares are not Preference shares are always
redeemable. According to redeemable. The company
Companies Act, 2013 cannot issue irredeemable
(Section 68), the company preference shares.
may buyback its equity
shares.

19.4.2 Debentures
The company issues debentures under its common seal. Debentures are the
debt for the company. The terms of payment as well as interest are mentioned
on the debentures. Section 2 (30) of Companies Act, 2013 defines debenture as
“Debenture includes debenture stock, bonds or any other instrument of a company
evidencing a debt, whether constituting a charge on the company’s assets or
not.”

36 Fig. 19.1 : Types of Debentures

Debentures are generally freely transferable. Debenture holders do not have Financial Management
rights to vote in the general meetings of the company. The interest paid to
debenture holder is charged against the profit of the company.

Types of Debentures
There are three types of debentures based on Convertibility, Security and
Redemption. Let us learn them in detail.

i) Convertibility : On the basis of convertibility, debentures are classified

into following types :
Convertible debentures : These debentures may be converted into equity
shares of the issuing company after a predetermined period of time. The
convertible debentures may be partly convertible debentures and fully
convertible debentures.
Partly Convertible Debentures (PCD): A part of these debentures may
be converted into equity shares in the future at the issuers notice. The issuer
company decides the ratio for conversion. It is generally decided at the
time of subscription.
Fully Convertible Debentures (FCD): These debentures are fully
convertible into Equity shares at the notice of the issuer company. The
issuer company decides the ratio of conversion. When these debentures are
converted into ordinary shares, investors get the status of ordinary
shareholders of the company.
Non-convertible Debentures: These are regular debentures which cannot
be converted into equity shares. Since these debentures do not have
convertibility features, their rates of interest are higher than convertible
debentures.
ii) Security : On the basis of security, debentures are classified into following
types:
Secured Debentures: These debentures are secured by a charge on the
fixed assets of the issuer company. In case the issuer company fails to make
payment of principal or interest, the assets of the issuer company may be
sold to make the payment of the secured debenture holders.
Unsecured Debentures: These debentures are unsecured. In case the issuer
company is not able to pay the principal or interest, the investors are
considered like unsecured creditors of the company.
iii) Redemption : On the basis of redemption, debentures are classified into
following types :
Redeemable Debentures: These are the debentures which are redeemed
or paid off after the termination of fixed term. The amount includes the
principal amount and the current year’s interest. The company may redeem
all the debentures at specified date. The company may also redeem a specific
number of debentures annually.
Irredeemable or Perpetual Debentures: These are the debentures which
do not have any fixed date of redemption. They are redeemed in case the
company is winding-up or they may be redeemed after a very long time.
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Functional Areas of Bearer of such debentures can not force the company to redeem their
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debentures.

Merits
a) Raising funds without allowing control over the company: The debenture
holders do not have right to vote. Thus, they can not intervene in the
management of the company. The company can raise funds without the
control of debenture holders.

b) Reliable source of long term finance: Debentures are ordinarily issued

for a fixed time. The company may use the funds raised by issuing
debentures. It facilitates long-term planning of the company.

c) Tax Benefits: Interest paid on debentures is treated as an expense. The

interest is charged to the profits of the company. It results into reduction in
tax liability of the company.

d) Investors’ Safety: Generally debentures are secured. When the company

is winding-up, they are repayable before any payment is made to the
shareholders. Interest on debentures has to be paid whether the company is
earning profit or loss.

Demerits
1) As you have understood that the interest on debentures have to be paid
every year whether the company earns profits or incurs losses. In case of
losses, payment becomes a burden for the company.

2) Generally the debentures are secured. The company creates a charge on its
assets in favour of debenture holders. If company does not own sufficient
amount of assets, the company may not be in a position to issue debentures.
If the assets of the company are mortgaged, these assets can not be issued
for further borrowing.

3) Debenture-finance enables a company to trade on equity. If the company

issues very large number of debentures, it may have adverse impact on
shareholders. The shareholders may get frustrated. As a result, the value
of shares may fall.

4) It may be a burden on the company during recession. At the time of recession,

the profits of the company may decline. In such cases, it may be difficult to
pay interest on debentures. The interest may keep on accumulating. The
accumulation of very large amount of interest may lead to the closure of
the company.

19.4.3 Venture Capital

These days, the venture capital has emerged as an important source of finance.
The investors invest in start-up companies, micro, small and medium size
enterprises with long-term growth perspective. The investment is made
particularly for starting the business and expansion for the business considering
the long-term growth potential. The capital invested in such project is known as
venture capital. The person who contributes capital in such project is known as
venture capitalist. It is an important method of equity financing for the long-
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term growth potential enterprises. The venture capitalists may be professionals Financial Management
in many fields. They provide funds for earning high returns. They take active
part in the management of the enterprises. They provide professional expertise
to the organisation.

Advantages of Venture Capital

Venture Capital provides fund as well as expertise to the company.
The enterprise may obtain large amount of equity finance.
The enterprise is not obligated to repay the fund.
The venture capital provides important information, resources, technical
assistance for the enterprises.

Disadvantages of Venture Capital

The founder may loose the control and autonomy because the investors
become part of the owners.
The finance through venture capital may be complex and lengthy.
This method of financing may be uncertain.
This method of financing may not be suitable for short-term.

19.4.4 Lease Financing

A lease is a contractual agreement whereby one party i.e., the owner of an asset
grants the other party the right to use the asset in return for a periodic payment.
In the lease financing the asset is given on rent for specified period. The owner
of the assets is known as the Lessor. The party whom the asset is given is called
the Lessee. The fixed amount is paid by Lessee to the Lessor for the use of the
asset which is known as lease rental. The lease contract is signed, which stipulates
the terms and conditions for regulation of the lease arrangements. The asset is
given back after the expiry of lease period. This finance may be used for
modernisation and diversification of the organisation. Lease financing may be
suitable for the business related to fast changing technological developments.
The Lessee shall compare the cost of buying the asset and the cost of leasing the
asset for entering to lease financing.

Types of Lease
There may be two types of lease financing. These may be finance lease and
operating lease. Let us learn them in detail.

a) Finance Lease: The Lessor transfers substantially all the risks and rewards
of ownership of assets to the Lessee for lease rentals. The Lessee is brought
in the same condition as he/she would have been if he/she had purchased
the asset. There are two phases of finance lease. The first phase is known
as primary phase. The primary phase is non-cancellable period. The Lessor
recovers his investment through the rent of the lease. The primary period
may last for indefinite period of time. The lease rental for the secondary
period is smaller than that of primary period.
Features of Finance Lease
1) In the lease financing, the Lessee gets a right to use an asset.
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Functional Areas of 2) The Lessor charges lease rent during the primary period of lease. The
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amount of the lease rent may recover the investment.
3) The amount of lease rent for secondary period is less.
4) The maintenance of asset is done by the Lessee.
5) The Lessor do not take the risk and reward related to asset.
6) The investment of Lessor is ensured because the lease is non-
cancellable.
b) Operating Lease
Lease which is not finance lease is called operating lease. In case of operating
lease, the risks and rewards incidental to the ownership of asset are not
transferred by the Lessor to the Lessee. The term of such lease is much less
than the economic life of the asset. The Lessee may not recover the total
investment through lease rental during the primary period of lease. The
Lessor usually provides advice to the Lessee for repair, maintenance and
technical know how of the leased asset. Thus, the operating lease is also
referred as service lease.
Features of Operating Lease
1) The term of lease is less than the economic life of the asset.
2) The Lessee can terminate the lease at a short notice. The penalty is not
charged for termination.
3) The technical know how is provided by the Lessor.
4) The Lessor bears the risks and rewards.
5) Lessor gives leasing an asset to different Lessee. The leasing facilitates
recovery of investment.

Advantages and Disadvantages of Lease Financing

There are many advantages and disadvantages of lease financing. Let us learn
them in detail :

Advantages of Lease Financing

a) To Lessor
1) Regular Income: The lease rental income is received by the Lessor
for the lease period. Thus, the Lessor gets regular and assured income.
2) Ownership: The ownership of asset is not transferred to Lessee. Lessee
bears the risks and rewards related to the asset.
3) Tax Benefit : The Lessor gets tax benefit by charging the depreciation
of the leased asset.
4) Profitability: The rate of return on lease rent is higher than the interest
payable on financing the asset. Thus, the leasing of asset is highly
profitable.
5) Growth Potential : Being the cost efficient financing, the leasing
business has been growing. This may facilitate the business during
40
 the depression period. Therefore, the growth potential of leasing may Financial Management
be higher than other financing business.
6) Investment Recovery : The Lessor may recover investment through
lease rentals.

b) To Lessee

1) Use of asset: The Lessee can use an asset by paying fixed rentals. He
need not spend large amount on the purchase of the asset.

2) Tax benefits: The lease expenses are chargeable to profits, hence, the
enterprise gets the tax benefits.

3) Cheaper: The lease financing is cheaper than other sources of finance.

4) Assistance: The technical support may be provided by the Lessor to

the Lessee for the leased asset.

5) Inflation friendly: The Lessee makes fixed payment in the form of

lease rent. The same fixed amount is paid when the cost of asset
increases. Thus, leasing is considered as inflation friendly.

6) Ownership: The Lessor offers the Lessee to purchase the asset by

paying less amount when the primary period expires.

Disadvantages

a) To Lessor

1) Unprofitable in case of inflation: The lease rent is fixed, therefore,

the Lessor gets the same amount even if the cost of asset increases.

2) Double taxation: The tax burden is doubled. At the time of buying

the asset as well as at the time of leasing the asset.

3) Greater chance of damage of asset: The asset may be used carelessly

by the Lessee because the ownership of asset is not transferred. Thus,
the asset may not be usable after the expiry of primary period.

b) To Lessee

1) Compulsion: The lease can not be cancelled. The Lessee is bound to

make the payment of lease rent when the asset is not used by him/her.

2) Ownership: The ownership is not transferred to Lessee. He/she can

not be the owner unless the asset is bought by him/her.

3) Costly: The Lessee pay the lease rental as well as the incidental
expenses related to the asset. Therefore, the lease financing may be
costlier than other financing.

4) Understatement of asset: The lease asset is not shown in the Balance

Sheet because Lessee is not the owner of asset. This leads to
understatement of the asset for the Lessee.

41
Functional Areas of Check Your Progress B
Management
1) What is the difference between equity shares and debentures?
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2) Write two merits and demerits of equity shares.
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3) Write two merits and demerits of debentures.
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4) What do you mean by venture capital?
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5) What is lease financing?
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42
 Financial Management
19.5 SECURITY MARKET
You have learnt the sources of finance being raised through equity shares,
debentures, venture capital and lease financing. Security Market is another
important source of raising finance. The Securities Market consist of primary
market and secondary market. In security market, the securities are bought and
sold on the basis of demand and supply of securities. It consists of equity markets,
bond markets and derivative markets. It plays a crucial role in the economy.
The fund is channelised from savers to investors by the security market. The
security market facilitates in the allocation of funds by channelising the fund to
the users of the fund. Let us learn them in detail.

19.5.1 Primary Market

In the primary market new securities are issued. It is also known as New Issue
Market. Issuers, Government and Corporate issue security in primary market.
It helps in raising resources and fulfills the requirement of investment. The
securities may be issued at face value, or at a discount/premium value. The
securities may be in the form of equity, debt, etc. The market participants may
issue the securities in domestic market as well as the international market.

In primary market, the issue is carried out through public issues or private
placement. A public issue does not restrict in investing. In private placement,
the issue is provided to select people. In terms of the Companies Act, 1956, an
issue becomes public if it results in allotment to more than 50 persons. This
means an issue of less than 50 persons falls in private placement. There are two
types of security issuers. These are : (i) Corporate entities, who issue mainly
shares, debentures, etc. and (ii) the Government, who mainly issue debt securities
like dated securities, treasury bills and others.
The price may reflect information about the issuer and his business. The risk
involved in the secondary market may attract the investors in the primary market.
There are various ways to raise capital or equity in primary market. These are :
1) Public Issue : In this issue, the securities are sold through IPO.
2) Rights Issue : In this issue, Shares are offered to existing shareholders on
pro-rata basis. This facilitates raising of supplementary capital.
3) Private Placement : Securities are sold to high profile investors. These
may be Venture Capitalists, Mutual Funds and Banks.
4) Preferential Allotment : Equity shares are issued to selected investors. A
listed company issues equity shares which may or may not be in accordance
with the market price.

19.5.2 Secondary Market

A market where securities are traded which were initially offered to the public
in the primary market and/or listed on the Stock Exchange is known as secondary
market. Majority of the trading are preformed in the secondary market. Secondary
market consists of equity markets and the debt markets.
The investors or participants trade the already held securities. This is done
considering the risk and return. Secondary market has two components : (i) The
over-the-counter (OTC) market and (ii) exchange-traded market. The Over the
43
Functional Areas of Counter Exchange of India Limited has provided the OTC market. The OTC
Management
market are informal markets where trades are negotiated. Most of the trades in
Government securities are done in the OTC market. Spot trades are not provided.
Cash market is also somewhat like spot market. In cash market, settlement takes
place after sometime. Trades takes place over a trading cycle, i.e. a day under
rolling settlement. Trades are settled after a two working days. Clearing
corporation clears and settles the trades done on the National Stock Exchange
of India Limited (NSE). In this way, notation and settlement guarantee are
provided. Almost all the trades are settled in DEMAT (dematerialisation) form.
NSE also provides a platform for trading of a wide range of debt securities. The
Government securities are also traded.
In the Secondary market, the trade may also take place for future date, this is
known as forward market. In this market, securities are traded for future delivery
and payment. There are two types of forward market i.e. Futures and Options.
In future market, standardised securities are traded for future delivery and
settlement. These Futures are on an underlying asset i.e. an index or a security
or even a commodity. In Options, securities are traded for conditional future
delivery. There are two types of Options. These are put and call Options. A Call
Options allows the owner to buy a security from the writer of the Option at a
predetermined price. A Put Option allows the owner to sell a security to the
writer of Options at a predetermined price. These Options also derive their value
from underlying security. NSE and the Bombay Stock Exchange (BSE) provide
trading of derivatives of securities.

You have learnt about the primary and secondary market. Let us learn the
difference between primary market and secondary market.

Difference between Primary and Secondary Market

Basis Primary Market Secondary Market

Meaning It is a new issue of market. The securities which have been
In this market, first time already issued, are bought and
dealings take place. sold in secondary market.
Type of buying There is direct buying. There is an indirect buying.
Financing Finances are raised for The trading of prior-issued
expansion and shares take place. Finances are
diversification. not raised.
Selling of security The securities are sold only The securities which have been
once. already issued are traded
several times.
Buying and Buying and selling take Buying and selling take place
Selling place between company and among investors.
investors.
Gain Company Investors
Intermediary Underwriters Brokers
Price There is a fixed price There is a price fluctuation. It
provided at the time of IPO. depends on the demand and
supply in the market.
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 Financial Management
19.6 ROLE OF SEBI
The stock market has grown over the year. The malpractices such as price rigging,
new issue unofficial premium, delay in delivery of shares, stock exchange rules
and regulations violation and others have also been noticed. Therefore,
Government of India took decision to set-up a regulatory body SEBI (Securities
Exchange Board of India).

SEBI is the regulator for the securities market in India. It is known as Securities
Exchange Board of India. The regulation facilitates smooth functioning of
security market. The statutory powers of SEBI are as follows :
It protects interests of the investors in securities.
It promotes the development of the securities market.
It regulates the securities market.
SEBI may conduct enquiries, audits and inspection as well as adjudicate offences.
It may register and regulate the market Intermediaries. It may also penalise in
case of violation of the Act. SEBI aims at the development of orderly security
markets.

Purpose and Role of SEBI

SEBI was formed to keep check on the malpractices and protect the interest of
investors. It focused on protecting the interest of issuers, investors and
Intermediaries as discussed below :
1) Issuers: SEBI provides safe market place to Issuers for raising the finance
fairly and easily.
2) Investors: SEBI aimed at protecting the investors and supplying them
accurate information.
3) Intermediaries: Professionally competitive market is provided by SEBI
for the Intermediaries.

Objectives of SEBI
The objectives of the SEBI are :
1) The activities of stock exchange are regulated.
2) The rights of investors are protected. Safety is ensured for their investment.
3) Establishes the balance between self regulation and statutory regulations.
4) Development and regulation of Code of Conduct for brokers, underwriters
and others.

Functions of SEBI
The functions of SEBI are:
1) Protective functions : SEBI aims at protecting the interest of the investors.
It provides safety of investment. The malpractices, fraudulent activities
and unfair trade practices are curbed. It promotes fair practices and provides
code of conduct for fair operations.
45
Functional Areas of 2) Developmental functions : SEBI promotes training for securities market
Management
Intermediaries. Stock Exchanges are encouraged to adopt flexible and
adoptable approach.

3) Regulatory functions : SEBI regulates the business in Stock Exchange.

Regulations, Rules and Code of Conduct have been prepared to regulate
the operations of the Intermediaries. It regulates the working of stock
brokers, mutual funds, take-over of companies, etc. It also conducts audit
of Stock Exchange.

Check Your Progress C

1) What is Primary market ?

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2) What do you mean by Secondary market ?

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3) What is SEBI?
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4) Write two functions of SEBI?

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5) State whether following statement are True or False. Financial Management

i) New shares are issued in Secondary market.

ii) Equity shares are paid dividend before the payment of dividend on
preference shares.
iii) The lease is not a contractual agreement
vi) Venture capital provides fund as well as expertise to the company
v) SEBI does not register and regulate the working of mutual funds.

19.7 LET US SUM UP

Financial Management means planning, organising, directing and controlling
the financial activities such as procurement and utilisation of funds of the
enterprise. It means applying general management principles to financial
resources of the enterprise. The objectives of the financial management are to
ensure the regular and adequate supply of funds, optimum utilisation of funds
and reasonable returns to the investment. The main objective of the financial
management is still a debatable issue that whether firm should focus on profit
maximisation or wealth maximisation. Every firm has a predefined goal or an
objective. Therefore, the most important goal of a financial manager is to increase
the owner’s economic welfare. Here economic welfare may refer to maximisation
of profit or maximisation of shareholders wealth. Therefore, Shareholders wealth
maximisation plays a very crucial role as far as financial goals of a firm are
concerned.

In order to earn the return, firm has to invest the money and in order to invest the
money firm has to look for suitable sources of funds. The sources of funds are :
Equity shares, Debentures, Venture Capital and Lease Financing. Equity shares
are the ownership of the company and help in raising the finance from the public.
It is considered as permanent source of capital although shareholder has the
share in the profit. Debentures are the kind of loan. In other words, any money
borrowed for a longer duration is known as debentures. They carry a fixed rate
of return.

Venture capital is financing that investors provide to start-up companies and

small businesses that are believed to have long-term growth potential. Leasing
provides the opportunity to secure the use of capital without ownership. It is
effectively a hire agreement. In security market, securities are bought and sold.
There are two types of securities market i.e. Primary market and Secondary
market. Primary market is the market where the first-time securities are traded.
It is done via an Initial Public offering. Secondary market is a place where further
buying and selling of securities/shares takes place. In other words, in secondary
market actually trading of shares take place. Primary market provides or generates
funding for the companies by letting them issue securities, while secondary
market provides them the platform to trade in those securities. SEBI i.e the
Securities Exchange Board of India which manages and monitor the securities
market. The purpose is to protect the interests of investors in securities, promote
the development of the securities market and regulate the securities market.

47
Functional Areas of
Management 19.8 KEY WORDS
Authorised Capital : Maximum amount of capital a company can issue.
Capital : The amount invested in the business for the
purpose of earning revenue.
Called-up Capital : The amount of nominal value of shares that has
been called up by the company for payment by
the subscriber.
Capital Reserve : Capital profit not available for distribution as
dividend. It is represented in Balance Sheet as
Reserves and Surplus under the heading
Shareholder’s Funds.
Debentures : A long-term security yielding a fixed rate of
interest, issued by a company and secured against
assets.
Equity Shares : Equity shares represent the ownership of a
company and thus, the capital raised by issue of
such shares is known as ownership capital or
owner’s funds.
Financial Management : Financial management is that managerial activity
which is concerned with planning and controlling
of firm’s financial resources.
Issued Capital : Part of authorized capital which is offered to
public for subscription. It cannot exceed
authorized capital.
Lease Financing : Where the owner of an asset gives another person,
the right to use that asset against periodical
payments. The owner of the asset is known as
Lessor and the user is called Lessee.
Paid-up Capital : Part of called up capital that the members of
company or shareholders have paid.
Profit Maximisation : Profits maximisation approach implies that the
functions of financial management/decisions
taken by financial managers should be oriented
towards maximisation of profits or income of the
firm.
Reserve Capital : It is part of increased capital and/or portion of
uncalled share capital of an unlimited company
which can be called only in case of winding- up
of the company.
Share Capital : Capital raised by issue of shares.
SEBI : Securities Exchange Board of India is the
regulator for the securities market in India.
48
Venture Capital : Financing that investors provide to start-up Financial Management
companies and small businesses that are believed
to have long-term growth potential
Wealth Maximisation : Wealth maximisation means maximising the Net
Present Value (or wealth) of a course of action.

19.9 ANSWERS TO CHECK YOUR PROGRESS

Answers to check your Progress (C)

5) i) False, ii) False, iii) False, iv) True, v) False

19.10 TERMINAL QUESTIONS

1) What is meant by Financial Management? Describe the functions and
objectives of Financial Management.

2) “Wealth Maximisation is preferred over Profit Maximisation”. Critically

examine.

3) Discuss the sources of raising finance through the equity shares and
debentures ? Compare their relative merits and demerits.

4) Elucidate the difference between Primary Market and Secondary Market?

5) How do Equity Share differ from Preference shares and Debentures?

6) Describe the financing through Venture Capital, explaining its merits and
limitations.

7) What is the meaning of Lease Financing? Explain its advantages and

limitations.

8) Explain the Role and Functions of SEBI?

49