6.

FINANCIAL MANAGEMENT
6.1 Introduction
Financial management is that managerial activity which is concerned with the
planning and controlling of the firms financial resources. It was a branch of
economics till 1890, and as a separate discipline, it is of recent origin. Still, it has
no unique body of knowledge of its own, and draws heavily on economics for its
theoretical concepts even today.
(or)

The planning, directing, monitoring, organizing, and controlling

of the monetary resources of an organization.

In the process of energy management, at some stage, investment would be required

for reducing the energy consumption of a process or utility. Investment would be
required for modifications/retrofitting and for incorporating new technology. It
would be prudent to adopt a systematic approach for merit rating of the different
investment options vis--vis the anticipated savings. It is essential to identify the
benefits of the proposed measure with reference to not only energy savings but also
other associated benefits such as increased productivity, improved product quality
etc.
The cost involved in the proposed measure should be captured in totality viz.
Direct project cost
Additional operations and maintenance cost
Training of personnel on new technology etc.

Based on the above, the investment analysis can be carried out by the techniques
explained in the later section of the chapter.

6.4 Financial Analysis Techniques

In this chapter, investment analysis tools relevant to energy management projects
will be discussed.
6.4.1 Simple Pay Back Period:
Simple Payback Period (SPP) represents, as a first approximation; the time
(number of years) required to recover the initial investment (First Cost),
considering only the Net Annual Saving:
The simple payback period is usually calculated as follows:
tsYearlybenefitsYearlytFirstperiodpaybackSimplecoscos=
Examples
Simple payback period for a continuous Deodorizer that costs Rs.60 lakhs to
purchase and install, Rs.1.5 lakhs per year on an average to operate and maintain
and is expected to save Rs. 20 lakhs by reducing steam consumption (as compared
to batch deodorizers), may be calculated as follows:
monthsyearsperiodpaybackSimple335.12060==
According to the payback criterion, the shorter the payback period, the more
desirable the project.
Advantages
A widely used investment criterion, the payback period seems to offer the
following advantages:
It is simple, both in concept and application. Obviously a shorter payback
generally indicates a more attractive investment. It does not use tedious
calculations.
It favours projects, which generate substantial cash inflows in earlier years, and
discriminates against projects, which bring substantial cash inflows in later
years but not in earlier years.

Limitations
It fails to consider the time value of money. Cash inflows, in the payback
calculation, are simply added without suitable discounting. This violates the
most basic principle of

Bureau of Energy Efficiency 1426. Financial Management

financial analysis, which stipulates that cash flows occurring at different points of
time can be added or subtracted only after suitable compounding/discounting.
It ignores cash flows beyond the payback period. This leads to discrimination
against projects that generate substantial cash inflows in later years.
To illustrate, consider the cash flows of two projects, A and B:

Investment Rs. (100,000) Rs.(100,000)

Savings in Year Cash Flow of A Cash flow of B
1 50,000 20,000
2 30,000 20,000
3 20,000 20,000
4 10,000 40,000
5 10,000 50,000
6 - 60,000
SHORT TERM BORROWING

An account shown in the current liabilities portion of a company's balance sheet.

This account is comprised of any debt incurred by a company that is due within
one year. The debt in this account is usually made up of short-term bank loans
taken out by a company.

Investopedia explains 'Short-Term Debt'

The value of this account is very important when determining a company's

financial health. If the account is larger than the company's cash and cash
equivalents, this suggests that the company may be in poor financial health and
does not have enough cash to pay off its short-term debts. Although short-term
debts are due within a year, there may be a portion of the long-term debt
included in this account. This portion pertains to payments that must be made on
any long-term debt throughout the year.

LONG TERM BORROWING

Loans and financial obligations lasting over one year.

In the U.K., long-term debts are known as "long-term loans."

For example, debts obligations such as bonds and notes, which have maturities
greater than one year, would be considered long-term debt. Other securities such as
T-bills and commercial papers would not be long-term debt because their
maturities are typically shorter than one year.
Definition

Amount owed for a period exceeding 12 months from the date of the balance
sheet. It could be in the form of a bank loan, mortgage bonds, debenture, or
other obligations not due for one year. A firm must disclose its long-term debt in
its balance sheet with its interest rate and date of maturity. Amount of long-term
debt is a measure of a firm's leverage, and is distinguished from long term
liabilities which may include supply of services already paid for.

Sources of Short-term Finance

In the previous lesson you have learnt about the various types of financial
needs. The need for finance may be for long-term, medium-term or for
short-term. Financial requirements with regard to fixed and working capital
vary from one organisation to other. To meet out these requirements,
funds need to be raised from various sources. Some sources like issue
of shares and debentures provide money for a longer period. These are
therefore, known as sources of long-term finance. On the other hand
sources like trade credit, cash credit, overdraft, bank loan etc.which make
money available for a shorter period of time are called sources of
short-term finance. In this lesson you will study about the various sources
of short-term finance and their relative merits and demerits.

Objectives

After studying this lesson, you will be able to:

discuss the purpose served by short-term finance;
identify and explain the various sources of short-term finance;
outline the merits and demerits of short-term finance.;

Purpose of Short-term Finance

After establishment of a business, funds are required to meet its day to

day expenses. For example raw materials must be purchased at regular
intervals, workers must be paid wages regularly, water and power charges
have to be paid regularly. Thus there is a continuous necessity of liquid
cash to be available for meeting these expenses. For financing such
requirements short-term funds are needed. The availability of short-term
funds is essential. Inadequacy of short-term funds may even lead to
closure
of business.

Short-term finance serves following purposes

1. It facilitates the smooth running of business operations by meeting

day to day financial requirements.
2. It enables firms to hold stock of raw materials and finished product.
3. With the availability of short-term finance goods can be sold on
credit. Sales are for a certain period and collection of money
from debtors takes time. During this time gap, production continues
and money will be needed to finance various operations of the
business.
4. Short-term finance becomes more essential when it is necessary
to increase the volume of production at a short notice.

Sources of Short-term Finance

There are a number of sources of short-term finance which are listed
below:
1. Trade credit
2. Bank credit
Loans and advances
Cash credit
Overdraft
Discounting of bills
3. Customers advances
4. Instalment credit
5. Loans from co-operatives

1. Trade Credit
Trade credit refers to credit granted to manufactures and traders by the
suppliers of raw material, finished goods, components, etc. Usually
business enterprises buy supplies on a 30 to 90 days credit. This means
that the goods are delivered but payments are not made until the expiry
of period of credit. This type of credit does not make the funds available
in cash but it facilitates purchases without making immediate payment.
This is quite a popular source of finance.
2. Bank Credit

Commercial banks grant short-term finance to business firms which is

known as bank credit. When bank credit is granted, the borrower gets a
right to draw the amount of credit at one time or in instalments as and
when needed. Bank credit may be granted by way of loans, cash credit,
overdraft and discounted bills.

(i) Loans
When a certain amount is advanced by a bank repayable after a
specified period, it is known as bank loan. Such advance is credited
to a separate loan account and the borrower has to pay interest on
the whole amount of loan irrespective of the amount of loan
actually drawn. Usually loans are granted against security of assets.

(ii) Cash Credit

It is an arrangement whereby banks allow the borrower to withdraw
money upto a specified limit. This limit is known as cash credit
limit. Initially this limit is granted for one year. This limit can be
extended after review for another year. However, if the borrower
still desires to continue the limit, it must be renewed after three
years. Rate of interest varies depending upon the amount of limit.
Banks ask for collateral security for the grant of cash credit. In
this arrangement, the borrower can draw, repay and again draw the
amount within the sanctioned limit. Interest is charged only on the
amount actually withdrawn and not on the amount of entire limit.

(iii) Overdraft
When a bank allows its depositors or account holders to withdraw
money in excess of the balance in his account upto a specified
limit, it is known as overdraft facility. This limit is granted purely
on the basis of credit-worthiness of the borrower. Banks generally
give the limit upto Rs.20,000. In this system, the borrower has to
show a positive balance in his account on the last friday of every
month. Interest is charged only on the overdrawn money. Rate of
interest in case of overdraft is less than the rate charged under
cash credit.

(iv) Discounting of Bill

Banks also advance money by discounting bills of exchange,
promissory notes and hundies. When these documents are presented
before the bank for discounting, banks credit the amount to
cutomers account after deducting discount. The amount of discount
is equal to the amount of interest for the period of bill. This part
has been discussed in detail later on in this chapter.

3. Customers Advances
Sometimes businessmen insist on their customers to make some
advance payment. It is generally asked when the value of order is
quite large or things ordered are very costly. Customers advance
represents a part of the payment towards price on the product (s)
which will be delivered at a later date. Customers generally agree
to make advances when such goods are not easily available in the
market or there is an urgent need of goods. A firm can meet its
short-term requirements with the help of customers advances.

4. Instalment credit
Instalment credit is now-a-days a popular source of finance for
consumer goods like television, refrigerators as well as for
industrial goods. You might be aware of this system. Only a small
amount of money is paid at the time of delivery of such articles.
The balance is paid in a number of instalments. The supplier charges
interest for extending credit. The amount of interest is included
while deciding on the amount of instalment. Another comparable
system is the hire purchase system under which the purchaser
becomes owner of the goods after the payment of last instalment.
Sometimes commercial banks also grant instalment credit if they
have suitable arrangements with the suppliers.

5. Loans from Co-operative Banks

Co-operative banks are a good source to procure short-term
finance. Such banks have been established at local, district and
state levels. District Cooperative Banks are the federation of
primary credit societies. The State Cooperative Bank finances and
controls the District Cooperative Banks in the state. They are also
governed by Reserve Bank of India regulations. Some of these
banks like the Vaish Co-operative Bank was initially established as
a co-operative society and later converted into a bank. These banks
grant loans for personal as well as business purposes. Membership
is the primary condition for securing loan. The functions of these
banks are largely comparable to the functions of commercial banks.

Merits and Demerits of Short-term Finance

Short-term loans help business concerns to meet their temporary
requirements of money. They do not create a heavy burden of interest on
the organisation. But sometimes organisations keep away from such loans
because of uncertainty and other reasons. Let us examine the merits and
demerits of short-term finance.

Merits of short-term finance

a) Economical : Finance for short-term purposes can be arranged at
a short notice and does not involve any cost of raising. The amount
of interest payable is also affordable. It is, thus, relatively more
economical to raise short-term finance.
b) Flexibility : Loans to meet short-term financial need can be raised
as and when required. These can be paid back if not required. This
provides flexibility.
c) No interference in management : The lenders of short-term
finance cannot interfere with the management of the borrowing
Sources of Short-term Finance :: 17
concern. The management retain their freedom in decision making.
d) May also serve long-term purposes : Generally business firms
keep on renewing short-term credit, e.g., cash credit is granted for
one year but it can be extended upto 3 years with annual review.
After three years it can be renewed. Thus, sources of short-term
finance may sometimes provide funds for long-term purposes.

Demerits of short-term finance

Short-term finance suffers from a few demerits which are listed below:
a) Fixed Burden : Like all borrowings interest has to be paid on
short-term loans irrespective of profit or loss earned by the
organisation. That is why business firms use short-term finance
only for temporary purposes.
b) Charge on assets : Generally short-term finance is raised on the
basis of security of moveable assets. In such a case the borrowing
concern cannot raise further loans against the security of these
assets nor can these be sold until the loan is cleared (repaid).
c) Difficulty of raising finance : When business firms suffer
intermittent losses of huge amount or market demand is declining
or industry is in recession, it loses its creditworthiness. In such
circumstances they find it difficult to borrow from banks or other
sources of short-term finance.
d) Uncertainty : In cases of crisis business firms always face the
uncertainty of securing funds from sources of short-term finance.
If the amount of finance required is large, it is also more uncertain
to get the finance.
e) Legal formalities : Sometimes certain legal formalities are to be
complied with for raising finance from short-term sources. If shares
are to be deposited as security, then transfer deed must be prepared.
Such formalities take lot of time and create lot of complications.
Demerits
(a) Limited amount : The amount advanced by the customer is subject
to the value of the order. Borrowers need may be more than the
a amount of advance.
(b) Limited period : The period of customers advance is only upto
the delivery goods. It can not be reviewed or renewed.
(c) Penalty in case of non-delivery of goods : Generally advances
are subject to the condition that in case goods are not delivered
on time, the order would be cancelled and the advance would have
to be refunded along with interest.

External Commercial Borrowing Part I

1.Introduction

External Commercial Borrowings (ECBs) play a significant role in any

developingeconomy since its domestic funds are usually unable to meet growing
demand, moreso when the cost of domestic borrowing is higher than that of
international funding.Raising ECBs by Indian residents directly adds to Indias
external debt and foreignexchange exposure and therefore, the same is highly
regulated by the RBI. Mismatchof tenure and usage of ECBs can be disastrous for
the economy as was evident fromthe South East Currency Crisis. Therefore, many
restrictions are placed by RBI toensure that short-term borrowings are not used
for long-term use and vice versa.Policy guidelines pertaining to ECBs have been
revised from time to time. Recently,on August 1, 2005 new guidelines for ECBs
have been announced. In this part, weshall discuss the provisions related to
raising of External Commercial Borrowingsunder the automatic route of Reserve
Bank of India.External Commercial Borrowings (ECBs) are a key component of
Indias overallexternal debt which includes,

inter alia

, external assistance, buyers credit, supplierscredit, NRI deposits, short-term

credit and Rupee debt. ECB guidelines, need to beassessed in the backdrop of
various external debt sustainability indicators relevant toemerging economic

2.NEEDS

External Commercial Borrowings (ECBs) are defined to include commercial

bankloans, buyers credit, suppliers credit, securitised instruments such as
floating ratenotes and fixed rate bonds etc., credit from official export, credit
agencies andcommercial borrowing from the private sector window of
Multilateral FinancialInstitutions such as International Finance Corporation
(Washington), ADB, IFC, CDCetc.Even loans from Foreign Equity Holders are
considered as ECBs.Thus ECBs mean foreign currency loan raised by residents
from recognised lenders.Financial leases and Foreign Currency Convertible Bonds
are also covered by ECBguidelines.

3.ECB Guidelines Historical prospective

ECBs, were governed by the Ministry of Finance. Government had

issuedconsolidated guidelines on policies and procedures for ECBs in July, 1999.
The saidguidelines were amended from time to time. The Central Government
had lastrevised these guidelines on 19th January, 2004. However, subsequently
RBI hadissued comprehensive Circular No. 60 dated 31st January, 2004, contents
of whichlater on were incorporated by way of amendments to the original
Notification No.3/2002-RB vide Notification No. 126/2004-RB, dated 13th
December, 2004.From 1st February, 2004 major restrictions were imposed on
raising ECBs, by Indianborrowers, such as ban on end use of ECB for working
capital, general corporate
purpose, cap of US$ 500 million per financial year under the Automatic Route
etc.Submission of ECB-2 return to RBI on a monthly basis duly certified by
thedesignated Authorised Dealer as well as a Chartered Accountant was
mademandatory with effect from 1st February, 2004. On April, 2005, RBI
permitted NGOsengaged in micro-finance activities to raise ECB under automatic
route vide itsCircular No. 40. The revised guidelines issued by the Government of
India on 19thJanuary, 2004 and the original comprehensive guidelines of 1999-
2000 havepractically become redundant in the light of these developments.RBI
has further amended its earlier ECB guidelines vide Circular No. 5, dated August1,
2005. Notification making amendments based on these guidelines is still
awaited.ECB guidelines can be divided in three broad periods. Prior to 1st
February, 2004,when there were less restrictions on raising ECB and the same was
allowed forgeneral corporate purpose including working capital requirements of
companies.From 1st February, 2004 to 31st July, 2005, ECBs were governed by
RBI guidelinescovered by the A.P. (DIR Series) Circular No. 60, dated 31st January,
2004, whichprohibited raising of ECB for general corporate purposes/working
capital and imposedseveral other restrictions and reporting requirements. New
ECB guidelines areannounced by RBI effective from August 1, 2005 which imposes
further restrictionsin terms of percentage of shareholding by the leaders,
permissible debt equity ratioand so on.Provisions of ECB discussed in this Article
are based on the latest RBI guidelines onECB covered by Circular No. 5, dated 1st
August, 2005.

4.Different schemes of ECB

There are three broad schemes or more appropriately, following facilities

underECB schemes:

i.Trade Credit

ii.Automatic Route

iii.Approval Route.
BALANCE SHEET ANALYSIS
Uses of Funds
1) Fixed Assets
2) Intangible Asets
3) Non Current Assets
4) Current Assets
Reserves
1) Subsidy Received From The Govt
2) Development Rebate reserve
3) Revaluation of fixed assets
4) Issue of Shares at Premium
5) General Reserves
Surplus
The credit balance in profit and loss account
Tangible Net Worth
This refers to the total funds arrived by paid-up capital , Reserves and P&L
Surplus
Less
Intagible Assets
Fixed Assets
Infrastructure like land & building
plant & machinery
Vehicles
Furniture & fixtures
 Depreciation
Straight line method
Written down Value Method
Remark : Dep added to profit to arrive repayment obligation especially in
term loans
Non Current Assets
Deferred recievables/Overdue recievables(like disputed amounts and Over
Due > 6 mths)
Non moving stocks/inventory/un usable spares
Investment/Lending to associate concern
Borrowing of the directors from the company
Telephone deposits/ ST deposits etc
Intangible Assets
Preliminary & Preoperative expenses
Deferred Revenue Expenditure
Goodwill
Trade mark
Patents
Rem : The o/s balance to be written off every year by charging P&L account

Profit & Loss Account

It is a summary of revenue earned and expenses incurred which ultimately results in profit or
loss of to the company

No defined format in law

Operating revenue = Sales revenue

 Non_operating revenue = Other income ( out of sale of investments, interest, commission and
discount etc)

Hence operating profit is a yard stick for operating profit of the company

Operating profit = Sales Revenue- Operating Cost

Gross Sales

Gross sales includes excise duty to be charged to the customer, central sales tax applicable,
state sales tax applicable, the discount o be allowed to distributors/dealers/customers. The
gross sales appears in the P&L account comprises of all the above part from the basic unit price.

Net Sales

The sales figure excluding all the factors explained above are the net sales.

Cost of production

This is the cost incurred right from the procurement of raw material to the finished good.

For ex in a garment firm following cost is incurred while production

1) cost of raw material cloth, buttons, canvas, hooks, zips etc

2) Maintenace of sewing machines

3) payment of wages to workers

4) power

5) washing, ironing,packing etc.

Selling And General Administarative Expenses

Maintaining office staff for admn & acctg

marketing effort

payment of salaries/Tr All to marktg personnel

All the expenses which are not directly connected to manufacturing are classifed as selling
and/or general expenses
Fund flow statement

A fund flow statement, better known as a cash flow statement, is an

important document in the accounting world. A fund flow statement shows
a company's inflows and outflows of funds. It is used to show investors,
stakeholders or owners where the company's money came from and where
it went.