Escolar Documentos
Profissional Documentos
Cultura Documentos
This reading material consists of a total of 52 pages and is to the best of my knowledge
sufficient. Also the reference for the material is Taxman, the handouts, slides and other
typed material, Khan and Jain and my class notes. Please ask Ankita, Janhavi and Geetan
incase any doubt arises as regards Corporate Governance or Geetan incase you want to
know something in Financial Management. You may still want to refer to any other
material (I’m still a little unsure as to which one must be used). Happy Reading & Best of
Luck!
Regards,
Ankita, Janhavi and Geetan
CONCEPT:
1. Refers to an economic, legal and institutional environment that allows companies
to diversify, grow, restructure and exit and do everything necessary to maximise
shareholder value
2. Governance deals with laws, procedures, practices and implicit rules that
determine a company’s ability to take informed managerial decisions.
3. Milton Friedman defines corporate governance as “the conduct of business in
accordance with shareholder’s desires, which generally is to make as much money
as possible while conforming to the basic rules of society embodied in law and
local customs”. This is CG in the narrowest sense.
4. Simplest and most common definition of CG is given by the Cadbury report is “
CG is the system by which businesses are directed and controlled”
5. OECD principles: “CG... Involves a set of relationships between a company’s
mgmt, its board, its shareholders and other stakeholders. CG also provides the
structure through which the objectives of the company are set, and the means of
attaining those objectives and monitoring performance are determined.”
6. CG represents the moral, ethical and value frameworks within which a company
takes decisions.
FEATURES:
1. There is no unique structure of CG in the developed world nor is one particular
type better than others.
2. Indian companies, banks and financial institutions can no longer afford to ignore
better corporate practices.
3. CG goes far beyond corporate law, many other aspects are also considered like
quality and frequency of financial and managerial disclosure, commitment to run
company with transparency etc
4. CG deals with laws, procedures, practices and implicit rules that determine a
company’s ability to take managerial decisions.
5. CG code to have real meaning must first focus on listed companies. However,
unlisted and private companies also need to be brought under the realm of CG
6. There is a diversity of opinion regarding beneficiaries of CG. The Anglo-
American system tends to focus on shareholders and various classes of creditors
7. Irrespective of differences between various forms of CG, all recognise that good
CG practices must at the very least satisfy atleast two sets of claimants: creditors
and shareholders.
8. The key to good CG is a well functioning, informed Board of directors.
NEED:
1. A corporate is a congregation of various stakeholders, namely, customers,
employees, investors, vendor partners, govt and society. A corporate should be
fair and transparent to all its stakeholders.
2. CG is about ethical conduct of a business. Ethical leadership is good for business
as the organisation is seen to conduct their business in line with expectations of all
stakeholders.
3. CG is beyond the realm of law. It deals with conducting business affairs with all
fairness to all stakeholders and actions that benefit greatest number of
shareholders.
4. Corporate need to recognise that their growth requires that cooperation of all the
stakeholders and such cooperation is enhanced by the corporate adhering to the
best CG practices.
5. CG is a key element in improving the economic efficiency of a corporate. Good
CG also helps ensure that corporate take into account the interests of a wide range
of constituencies. Also ensures that their Board is accountable to the shareholders,
help operate for benefit of society
6. Failure to implement good CG can have a heavy cost beyond regulatory
problems.
7. Credibility offered by good CG also helps maintain the confidence of investors
and reduce cost of capital and induce more stable source of financing
8. Often increased attention on CG is due to huge financial crisis. For instance the
Asian financial crisis brought into subject the concept of CG in Asia.
9. CG is a concept, rather than an individual instrument. It includes debate on
appropriate management and control structures of the company.
10. The most common school of thought would have us believe that if mgmt is about
running businesses, governance is about ensuring that it is run properly. All
companies need governance as well as mgmt.
OBJECTIVES OF GOOD CG:
1. To promote a healthy environment for long term investment.
2. To create trust in the corporate and its abilities.
3. To promote business development.
4. To improve efficiency of the capital markets.
5. To enhance the effectiveness in the service of the real economy.
PRINCIPLES:
1. People are more important than processes
2. Shareholder accountability
3. External audit must be independent and penetrating
4. Disclosure and transparency are crucial to market integrity
5. There must be an appropriate regulatory regime to back these obligations
OECD (organisation for economic co-operation and development):
1. Issued OECD principles of CG in 1999
2. Has become an international benchmark for policy makers, investors and other
stakeholders worldwide.
3. Advanced the CG agenda and provided specific guidance for legislative and
regulatory initiatives of both OECD and Non- OECD countries
4. Financial stability forum has designated the principles as one of the 12 key
standards for sound financial system.
5. Principles offer non-binding standards and good practices as well as guidance on
implementation
6. OECD PRINCIPLES:
i. Ensuring the basis for an effective CG framework
ii. The rights of shareholders and key ownership functions
iii. The equitable treatment of shareholders
iv. The role of stakeholders in CG
v. Disclosure and transparency
vi. The responsibilities of the board
IMPACT:
CG on performance, there are basically 2 models to be looked at:
• Stakeholder’s model
• Shareholder’s model
COMPONENTS:
1. It must include the framework of a strong performance orientation
2. It needs to be incorporate leadership and management imperatives that can lead to
strong financial and strategic performance
3. Financial disclosure is a critical component of effective CG
4. Human resource management is another key component
5. Board of directors is the pillar on which The CG system stands.
ADVANTAGES/ BENEFITS:
Good CG provides
1. A competitive edge in the global market
2. Enables companies to raise capital widely
3. Easily and economically
4. Improves employee morale
5. Generates higher productivity
6. Well governed companies last longer, stand the test of time and changing
environment
EFFECT OF NON-IMPLEMENTATION OF CG:
1. A school of thought prevails on the cost-benefit analysis, whether the cost of good
governance reforms is too high
2. Failure to implement good governance procedure has a cost beyond mere
regulatory problems
3. Companies suffer a significant risk premium when competing for scarce capital in
today’s public markets
2.1 Introduction
3. A very important concept in corporate law is the ‘piercing of the corporate veil’. This
doctrine was established in the case of Solomon v. Solomon. Solomon had a boot
manufacturing business under a sole proprietorship. He later felt that it would be
advantageous to him to form a company and hence distributed a share each amongst his
family members keeping the bulk to himself, so as to satisfy the requirements of English
law which makes it mandatory to have a minimum number of shares to incorporate a
company. His sons and he became the directors of the company. The company had
several creditors, Solomon being one of them. Later the company started doing badly, so
he filed for bankruptcy. Being a secured creditor, Solomon asked for satisfaction of his
claims first. The other creditors instituted a suit for fraud against him. The House of
Lords on the contrary held that the shareholders (including Solomon) have a distinct
personality as compared to the company and thus Solomon was entitled to get his money
back. This case was highly criticized. Hence, incorporation leads to creation of a
corporate veil between the company and the shareholder. Courts need to pierce this veil
and hold persons in default accountable.
6. As per S.111 of the Companies Act, the Directors of a Company have a right to refuse
registration of a person as shareholder/member. This is only in case of a private company
(Amendment of 2000 stated that this provision cannot apply to a public company) as in a
public company there are no restrictions on transferability of shares. This is generally
done as private companies are essentially closed concerns. Also, an increase in the
number of shareholders would lead to crossing the statutory limit of 50.
7. A company is very vaguely defined under the Companies Act. As per the Act, a
company is one which is registered under the Companies Act.
8. There is a difference between winding up and dissociation of a company. Winding up
leads to dissociation and is a long process by itself. Liquidators need to be appointed to
decide about the distribution of assets. Dissociation is when the company actually comes
to an end. Hence, it may take a very long time and this might lead to depreciation in value
of assets, development of new technology, etc.
9. A person can become the director of a maximum of 15 companies.
10. As per the Companies Act, 11% profits must go to the Company.
11. A company is formed in the following manner-
(a) Promoters come up with the idea of forming the company and float the same amongst
others and get consensus.
(b) Permission is sought from the Registrar of Companies.
(c) Once the registrar is satisfied that all requirements have been met, he gives permission
by way of a letter/certificate of incorporation. For public companies, even a letter of
commencement is required from the registrar.
(d) Now shares may be floated, funds may be raised and the company can be started. A
company needs to be compulsorily registered with a stock exchange before it floats its
shares.
12. The basic documents required by the registrar to give permission are the MoA and the
AoA. This is mainly to know about what projects the company would indulge in, sector
in which it is working, financial status, etc.
13. The MoA states the objects of the company and the framework within which it should
work. It must always comply with the Companies Act. An AoA on the other hand
prescribes the internal rules and regulations which govern the company and the conduct
of its members. The AoA must never contain what is not allowed under the MoA. Non-
adherence to the MoA and AoA will attract penalties. It may also lead to repudiation of
contract with the company. If the company doesn’t continuously follow its objective, it
may be wound up (loss of substratum).
14. The MoA must necessarily contain the following 5 clauses-
(a) Name clause- This must state the name of the Company. Such name must not be the
name of another registered company as it leads to ambiguity and may even lead to fraud.
A company cannot also register with a name which has ‘bharat’, ‘national’, ‘hindustan’,
etc. in it. The name of a partnership generally has the name of its partners.
(b) Liability clause- This clause shows the liability of the company which may be limited,
unlimited, guarantee liability (company where directors guarantee to pay more than what
they have put in-check), etc.
(c) Registered office clause- This specifies the name of the company’s registered office
where all the official communications would be sent. Further, the Companies Act
provides that AGM s must be held in a city where the registered office of the company is.
(d) Capital clause- The current financial status of the company need not be depicted as
the promoters and others wouldn’t have collected as many funds. What needs to be
shown is the authorized capital or the amount the company wishes to raise by way of
public issue in the future. For a private company, minimum authorized capital is 1 lakh
while for a public company it is 5 lakhs. The authorized capital is the maximum a
company can collect. It cannot go beyond this no matter how many times shares are
issued. But only a part of the authorized capital is issued to the public at a certain point of
time. This is the issued capital. The entire amount of authorized capital need not be
issued. Out of this, the public may either oversubscribe or undersubscribe shares. This is
the subscribed capital. A company cannot go for allotment of shares unless 90% of its
shares have been subscribed to. Generally, underwriters take up shares to fulfill this
requirement under an underwriters’ agreement. Next is the paid up capital or the amount
actually received by the company from shareholders. Generally the company goes for
calling on shares rather than floating shares when it is in need of funds. The shareholders
owe a debt to the company which needs to be paid back when asked for. If not paid back,
the company may forfeit shares of the shareholder and give it to someone else.
(e) Object clause- This final clause mentions the objects of the company and the
boundaries within which it must work.
14. The MoA is a public document. Once a company is registered, any person from the
general public may approach the registrar of companies to show the MoA on payment of
a certain fees.
15. The MoA is generally drafted flexibly so that it doesn’t require frequent amendments
later on.
1. A share is the smallest indivisible unit of a company. A share may not be further
divided but there may be joint ownership of a share.
2. Generally, shareholders’ interest is given primacy in a company as they are regarded as
the owners and major stakeholders of the Company. The shareholder theory focuses just
on this.
3. On the other hand, there is a stakeholder theory which states that there are other
stakeholders as well to whom the company is responsible and these stakeholders are
equally important as shareholders. The stakeholders in a company include shareholders,
employees (including directors), creditors, suppliers, customers, investors, government,
society, etc.
4. The reasons why these stakeholders associate with the company may be illustrated
with the help of the following table-
5. As per the stakeholder theory, incase there is a conflict of interests, interests of certain
stakeholders including shareholders must be sacrificed or moderated to fulfill the basic
demands of other stakeholders.
6. However, the stakeholder theorists greatly underestimate the extent to which
shareholder interests may help in furthering interests of other stakeholders.
7. Milton Friedman once said that ‘social responsibility of business is to maximize
profits’. This is opposed to the stakeholder theory which states that a company owes
responsibility to all its stakeholders on whom it depends. There are several types of
stakeholder theories given, which are as follows-
(a) Ontological Stakeholder theory- This theory is about the fundamental nature and
purpose of a corporation. It says that the very purpose of a firm is to coordinate
stakeholder interests.
(b) Explanatory Stakeholder theory- This theory explains as to how corporations and their
managers actually work taking into consideration stakeholder interests.
(c) Strategic Stakeholder theory- This theory states as to how devoting resources and
attention towards stakeholder interests will lead to positive outcomes.
(d) Stakeholder theory of Branding and Corporate Culture- This theory states that how
paying extra attention to stakeholders improves a company’s branding and adds to its
corporate culture.
(e) Deontic Stakeholder theory- This theory states the legitimate interests and rights and
stakeholders vis-à-vis the duties of corporate management.
(f) Managerial Stakeholder theory- This involves incorporating theories such as human
resource management, leadership, operations research, etc. which helps leaders and
managers realize the benefits of deontic stakeholder theory.
(g) Stakeholder theory of Governance- This theory deals with how stakeholder groups
could control the management.
(h) Regulatory Stakeholder theory- This theory is about how the government must
regulate businesses to protect certain stakeholder rights and interests.
(i) Stakeholder theory of Corporate Law- It deals with how corporate law should be
restructured to reflect principles and practices under the Ontological and Deontic
theories.
1. The three main aspects of good governance are transparency, accountability and
fairness.
2. It is generally the board of directors or the auditors who may be made accountable for
acts done.
3. Fairness involves protection against insider trading and protection provided to
investors. Insider trading involves exchange of inside information by employees and
others within the company with outsiders. Such information may then lead to unfair
advantage to outsiders who would deal with shares based on the information provided.
Another component of fairness is equal pay for equal work.
4. Corporate Governance came about somewhere in the late 70s and the 80s. It grew
majorly in the 90s. Every governance mechanism has seen to have developed after some
corporate scam. For e.g. SEBI made new rules after the Harshad Mehta scam.
5. Corporate Governance may have said to have started after the Watergate scandal
wherein there was a lot of political spying which on investigation revealed had been
funded by several corporates. President Nixon resigned after the incident and the Unfair
Trade Practices Act was brought into the picture. Thereafter, companies had to
compulsorily provide accounts about what they were doing with people’s money.
6. In UK as well in the 80s a number of companies went bankrupt and thus the London
Stock Exchange appointed the Cadbury Committee to make recommendations for the
same.
7. The main problem was that huge companies showing large profits collapsed. This
made the public question management practices in such companies. Hence, it affected
public confidence.
8. There are 3 stages in the downfall of a company, namely-
(a) Bad management- This is the first stage when profits start dipping, the confidence of
shareholders and creditors go down, etc. This is an early stage of detection and can be
managed with the help of internal controls. Further, shareholders might still want to stay
with the company.
(b) In the second stage, the profits dip further, shareholders start selling their shares and
moving out, creditors become more conscious and start charging higher rates of interest,
credit rating agencies which rate corporate performance also give bad reviews, there are
negative reviews by the media, etc. At this stage it becomes a little more difficult for the
company to bounce back. If the company still does nothing it goes into the 3rd stage.
(c) In this stage revival is difficult and the company may ask for external help from the
government and its agencies like the BIFR. This also comes under S.424 of the
Companies Act. This is the stage when the company goes in for revival and
rehabilitation. Generally there is a fund for the same wherein all companies contribute
about 1% of their profits.
9. Some important provisions under the Companies Act as regards good governance
include-
(a) S.425- Voluntary winding up of companies or winding up by tribunals. After the 2002
amendment, winding up by courts has been omitted. (check)
(b) S.292A- Audit Committees (new addition after 2002 amendment)
(c) S.192A- Postal Ballot system. It was suggested by the Kumarmangalam Birla
committee that this system be used for AGM s. There is as such no compulsion on
companies to go for the same. In 1997, a working committee was set up to look into this
system. It pointed out certain drawbacks like the problem of the mail reaching within a
certain time period, lesser scope for discussion, etc. Also, since the method of present and
voting is followed in AGM s, the problem is that if the votes don’t come in time, the
actual result may never be ascertained.
(d) S.10- National Company Law Tribunal to decide all disputes in place of the Company
law board. From this tribunal the case would go to the appellate company law tribunal
and finally to the Supreme Court. However, this tribunal has not been set up as its
validity was challenged in the President Bar Association’s case (2004) which is still
pending in the Madras High Court. Hence, the Company law board has been settling
disputes as of now.
(e) S.56- Prospectus which must give a true and fair picture of the company.
(f) S.5- meaning of officer in default.
(g) S.7-interpretation of persons according to whose instructions directors are supposed to
act.
(h) S.12- formation of an incorporated body
(i) S.13-requirements of MoA
(j) S.14- form of MoA
(k) S.15-Printing, signatures of subscribers of MoA. Subscribers automatically become
members of the company as well as directors.
(l) S.16-alteration of MoA
(m) Ss. 26-31-AoA
(n) S.41- member of a company
(o) S.51- service of documents on company. This has to be sent to the registered office
and service of documents on directors is regarded as knowledge of the company if done
during the course of employment.
(p) s.58-experts’ consent to issue prospectus
(q) S.69-allotment of shares
(r) S.71- effect of an irregular allotment. This gives one the right to avoid the contract.
(s) Ss. 165-197-meetings- Includes GM, AGM, BoD meetings, Shareholder meetings,
creditors’ meetings, etc.
S.166- AGM s. There must be atleast 1 AGM every year and the gap between 2
successive AGM s can’t be more than 15 months.
S.174- Quorum. This is required for a valid meeting.
S.171-Notices. The general notice period is 21 days but the same may be changed in the
AoA. Meetings are generally called by directors. But, they can also be called by
Shareholders in which case they must inform the board about the same. If one has 1/10th
of the paid up capital of a company, he may ask the directors to convene a meeting.
(s1) S.205-dividends and their payment
Ss. 209-234- Accounts and Audits-
(t) S.215- authentication done by directors
(u) S.217-Board’s report with respect to financial matters
(v) S.221- disclosures
(w) S.224-remuneration of auditors
S.226- qualifications and disqualifications of auditors
(x) S.227- powers and duties (check)
(y) S.397 and 398-oppression and mismanagement
(z) S.433- winding up by court
10. Generally Shareholders cannot monitor the Company due to reasons mentioned
earlier and also because they are too many in number.
11. Hence, there are provisions for independent directors, audit committees, etc. to
monitor directors and others. However this becomes very difficult especially in family
based companies wherein actually only one person is at the helm of affairs.
12. It has been stated that both control and encouragement with respect to directors is
required. When directors are held accountable it makes them take calculated risks
because of which the business becomes profitable.
13. Generally listed companies must follow corporate governance principles else they
would be delisted. As regards unlisted companies, they can choose what principles they
would want to follow.
1. Among the most prominent corporations in the world are the ones controlled by large
business families. These firms are passed on to heirs and show signs of dynastic control.
2. A family firm at the apex controls publicly traded firms which then control other
publicly traded firms and so on. At each level of the pyramid, public shareholders
contribute a minority equity stake.
3. In these firms, the managers serve at the pleasure of the family and not the
shareholders.
4. Although the owner of the company at the apex pyramid controls companies in the
lower tiers of the pyramid, its actual investment in such companies is often very less.
Hence, these families can easily control a major part of the corporate sector as they
control assets worth a lot more than their actual wealth.
5. The situation is very different in the US and UK wherein the firms are widely held and
are mainly free standing entities. They are widely held as they have no dominant
shareholder and are free standing because they own stock in no other domestically listed
firm and no other domestically listed firm owns stock in them.
6. One advantage of such family based firms is that they are free from agency based
problems. This is mainly because large shareholders would rarely give a chance to
managers to neglect the firm and deal in mismanagement.
7. However, the major problem is that instead of the managers, it is the controlling family
which can actually end up spending a lot of public funds. This is mainly because such
firms hold shares of other firms in the pyramid as well which are publicly traded.
8. Another problem is that widely held firms are threatened by hostile takeovers which
are not possible when it comes to family based firms. Also, institutional investors cannot
force their representatives on the board where 50% of the votes are held by members of
the family.
9. Further, in such pyramids, there is generally a lot of transfer of funds from firms to the
controlling body. This is done by way of tunneling. (Read handout for exact meaning and
example)
10. However, this effect is weaker in countries where there is better legal protection for
public shareholders and in pyramid firms for outside shareholders. Both law and large
independent shareholders help reduce tunneling.
11. Hence, the contention that family based firms reduced agency problems may be
rebutted as agency problems still exist in firms at the lower levels of the pyramid. Also,
the controlling firm cannot be easily ousted and also due to tunneling.
12. An argument in favour of such firms is that the controlling family is able to monitor
the activities of the firm more efficiently as compared to public shareholders. However it
has also been observed that such concerns avoided risks and curtailed expansion.
13. Another argument presented in favour of these companies is that due to family
relationships, the directors are closer and hence there is smooth functioning of the
company’s activities. This however has been contradicted by the fact that most family
based companies have a lot of in-fighting going on as in case of Reliance.
14. It has been seen that in economies where there is poverty, illiteracy, corruption, etc.
such firms work the best. It has been said that in such systems pyramid group firms
provide capital and labour to each other. They also buy and sell goods amongst
themselves.
15. However a problem associated with this is that physical capital is often over used and
more productive applications outside the organisation are neglected. The more the capital
is efficiently allocated within the firm, the more misallocation of capital is there in the
economy.
16. Also, firms like these exist in corrupt nations as they have close connections with
politicians and are more likely to return political favours by using the public’s money.
17. Such families do not like the entry of professional managers who they feel cannot be
trusted and only work to further their self interest. They are generally allowed into the
firm through marriages.
18. Generally a well developed legal and regulatory system would want the families to
sell out or allow outsiders into the firm so that greater control may be exercised.
19. A reason why in some countries control pyramids do not exist may be their taxation
system as in case of the US wherein a tax is imposed at every level of the pyramid
thereby discouraging such organisations. Also, in the US, the Public Utilities Holding
Companies Act banned pyramiding outright among public utility firms.
20. Another way is by levying an inheritance tax as has been done in Canada in the
1970s.
21. It has also been pointed out that in economies where there are control pyramids, the
politics is mainly socio-democratic. While in countries where firms are widely held,
liberal politics thrives.
22. Another way in which such firms may be controlled is by introducing competition by
way of liberalisation and globalisation.
23. Inspite of the existence of such firms in countries like Hong Kong, controls have been
exercised and the economic crisis of the 90s was combated because of a strong banking
system and equity markets.
Important Info-
THE BOARD OF DIRECTORS
1. The board should meet regularly, retain full and effective control over the
company and monitor the executive management.
2. There should be a clearly accepted division of responsibilities at the head
of a company, which will ensure a balance of power and authority, such that no
one individual has unfettered powers of decision. Where the chairman is also the
chief executive, it is essential that
3. There should be a strong and independent element on the board, with a
recognised senior member.
4. The board should include non-executive directors of sufficient calibre
and number for their views to carry significant weight in the board’s decisions.
5. The board should have a formal schedule of matters specifically reserved
to it for decision to ensure that the direction and control of the company is firmly
in its hands.
6. There should be an agreed procedure for directors in the furtherance of
their duties to take independent professional advice if necessary, at the
company’s expense.
7. All directors should have access to the advice and services of the
company secretary, who is responsible to the board for ensuring that board
procedures are followed and that
8. Applicable rules and regulations are complied with. Any question of the
removal of the company secretary should be a matter for the board as a whole. ‘_
NON-EXECUTIVE DIRECTORS
1. Non-executive directors should bring an independent judgement 10 bear
on issues of strategy, performance, resources, including key appointments, and
standards of conduct.
2. The majority should be independent of management and free from any
business or other relationship which could materially interfere with the exercise
of their independent judgement. apart from their fees and shareholding. Their
fees should reflect the time which they commit to the company.
THE CODE OF BEST PRACTICE
I. Non-executive directors should be appointed for specified terms and
reappointment should not be automatic.
II. Non-executive directors should be selected through a formal process and
both this process and their appointment should be a matter for the board as a
whole.
EXECUTIVE DIRECTORS
i) Directors’ service contracts should not exceed three years without
shareholders’ approval.
ii) There should be full and clear disclosure of directors’ total emoluments
and those of the chairman and highest-paid UK director, including pension
contributions and stock
iii) options.
iv) Separate figures should be given for salary and performance-related
elements and the basis on which performance is measured should be explained.
v) Executive directors’ pay should be subject to the recommendations of a
remuneration committee made up wholly or mainly of non-executive directors.
REPORTING AND CONTROLS
a. It is the board’s duty to present a balanced and understandable
assessment of the company’s position.
b. The board should ensure that an objective and professional relationship is
maintained with the auditors.
c. The board should establish an audit committee of at least three non-
executive directors with written terms of reference which deal clearly with its
authority and duties.
d. The directors should explain their responsibility for preparing the
accounts next to a statement by the auditors about their reporting responsibilities.
e. The directors should report on the effectiveness of the company’s system
of internal control. The directors should report that the business is a going
concern, with supporting assumptions or qualifications as necessary.
1. This committee looked into the problem related with senior executives getting a major
part of profits as remuneration. This was a matter of concern for investors.
2. Some of the main issues dealt by this committee were-
(a) Role of remuneration committee in setting remuneration packages of CEO s and other
directors.
(b) Required level of disclosure needed by shareholders with respect to remuneration of
directors and whether there is a need to obtain shareholder approval.
(c) Specific guidelines for determining remuneration policy for directors.
(d) Service contracts requiring payment of remuneration to directors in case of removal
for unsatisfactory performance.
3. This committee also recommended the constitution of a remuneration committee
composed of non-executive directors.
4. However, it didn’t gain much acceptance as it didn’t lay down any new policies to be
followed and merely reiterated the Cadbury Committee Report.
1. It mainly focused on consolidating the best provisions under the previous reports.
Another code came out in 2003.
2. It looked into shareholders’ interests as well as the way in which the board must
function.
1. It was given by Paul Myner who was commissioned by the government to look into
factors affecting investment decision making of institutions.
2. It was observed that various problems were created due to unrealistic demands of
pension funds thereby burdening investment consultants.
3. Questions on objectives of fund managers came up.
4. Recommendations were given on decision making and the flexibility with which they
perform their functions.
1. The collapse of Enron happens to be one of the biggest corporate scams in the business
world. It has been said that the auditing firm Andersen couldn’t detect mismanagement
by Enron due to an unconscious bias, organizational flaws and emphasis on marketing
non-audit services to clients for profits. Sherron Smith Watkins had tried to
unsuccessfully blow the whistle on Enron’s aggressive accounting policies.
2. The prime job of an auditor is to compare financial statements of a company with other
notes about the firm’s assets and liabilities during a given period so as to assess whether
the company has presented a fair picture of its financial condition as per accepted
accounting principles. However, this only provides reasonable assurance about the
veracity of the financial statements.
3. It has been observed that even in the most organised audit, fraud may not be as easily
detected as compared to unintentional errors. Thus, investors expect auditors to be a lot
more careful as regards frauds in financial statements and disclosures.
4. A jury convicted Andersen on the charge of obstructing justice. Andersen stated that its
audits failed to require Enron to mention about 2 special purpose entities (SPE) in its
financial statements. At that time, it was required that unrelated parties must own an
investment upto atleast 3% of the fair value of an SPE’s asset in order to avoid
consolidation. Originally, Andersen’s audit team declared that the unrelated parties held
more than 3% of the subsidiary’s residual equity and thereby fulfilling the required
criteria. However, later on Andersen claimed that it had reached such judgment in error
and asked Enron to correct the error. Immediately after Andersen’s conviction, the Wall
Street Journal in an article highlighted inadequate disclosures, questionable transactions
with other SPE s, premature recognition of revenue, etc.
5. The reasons for such an unconscious bias on the part of Andersen were said to be due
to the following reasons-
(a) Ambiguity- Accounting is an art and depends on the degree of skill and
professionalism exercised by the auditor. Also, auditing gives a company numerous
options to choose from.
(b) Attachment- The auditor may give a clean chit to the firm due to present or future
business interests with the firm.
(c) Approval- An audit essentially endorses or rejects the accounting choices that the
client’s management has made.
(d) Familiarity- People are often less willing to harm individuals they know and such
relationships grow with time.
(e) Discounting- This is the human tendency to place more emphasis on the short term
effects of decisions rather than long term effects.
(f) Escalation- Unconscious biases may also make auditors escalate only the minor
mistakes in the client’s financial statements. Atleast on 4 occasions Andersen allowed
Enron to hide debt and inflate earnings.
6. When fees for non-audit services amount to a large part of earnings from the firm, the
audit firms tends to have bias towards the firm in order to save its business.
7. The Sarbanes-Oxley Act which came up subsequently after this scam consists of the
following provisions to solve such problems-
(a) S.301- Required SEC to prescribe rules asking securities’ exchanges and securities’
associations to prohibit listing of companies which don’t have an audit committee
consisting primarily of independent directors in place. Such a committee has the power of
hiring, firing and compensating the company’s auditors. This committee has been
instituted in most publicly traded companies.
(b) S. 201- It lists several services as ‘prohibited services’ and out of the scope of audit
firms such as bookkeeping services, financial information systems design, management
or human resource services, etc. The auditor may however render tax services to the
client.
(c) S.202- This section requires the audit committee to review all audit and non-audit
services.
(d) S.203- Most accounting firms cannot perform audit services for a publicly traded
company, if the lead audit partner or reviewing audit partner has performed audit services
for the company in its last 5 fiscal years.
(e) S.206- It prohibits an audit firm from auditing accounts of a firm which has employed
such a person to a high level position who had served in the audit team in the past year.
Thus, a year of ‘cooling-off’ has been suggested by the SEC.
(f) The rules also require the rotation of the lead and concurring partners on an audit team
every 5 years.
(g) The Act also creates the Public Company Accounting Oversight Board (PCAOB) to
register, regulate and inspect public accounting firms that audit publicly traded
companies. S.102 requires such companies to register with the PCAOB and each
application must contain a statement of the firm’s quality control policies for its
accounting and auditing practices. The PCAOB may also conduct investigation or
disciplinary proceedings when required.
(h) S.207- It directs the Comptroller General to study the effects arising from the limits
on an audit firm’s association with a company and submit such reports to Congressional
committees within a year from the commencement of the Act.
(i) This Act doesn’t apply to closely held firms or non-profit organisations.
1. The BoD must consist of atleast 50% non-executive directors. If the chairman is a non-
executive director, the board must consist of atleast 1/3rd independent directors but if the
chairman is an executive director, the board must consist of atleast 1/2 independent
directors.
2. An independent audit committee must be set up by the board.
3. The board should set up a remuneration committee to determine the company’s policy
on specific remuneration packages for executive directors.
4. The board should set up a committee under the chairmanship of a non-executive or
independent director to look into shareholders’ issues.
5. The board should delegate share transfer responsibilities to an officer or committee or
to the registrar and share transfer agents who must look into the same atleast once every
fortnight.
6. The Corporate Governance section of the Annual Report should contain details of
every form of remuneration paid to the directors including salary, incentives, etc.
7. Board meetings must be held atleast 4 times a year with a maximum gap of 4 months
between 2 successive meetings. All information recommended by the SEBI committee
must be placed before the board.
8. The Directors’ Report, Management Discussion and Analysis Report must all form
part of the annual report to shareholders.
9. All company related information like quarterly results and presentations made by the
company to analysts must be put on the official website.
10. A special section must be dedicated to Corporate Governance in the Annual report
with details of the level of compliance achieved by the Company. This must highlight
non-compliance with any mandatory requirements and extent upto which non-mandatory
requirements have been adopted.
11. The non-executive chairman must be allowed to keep an office at the company’s
expense and be reimbursed for expenses incurred in performing his duties.
12. No director should be a member of more than 10 committees and chairman of more
than 5 committees across all companies of which he is a director. All directors must
disclose to a company about their membership of committees of other companies.
13. Disclosures to be made by the management to the Board as regards all material,
financial and commercial transactions which includes dealing in company shares,
commercial dealings with bodies that have shareholders, etc.
14. The half yearly declaration of financial performance shall be sent to each shareholder.
15. Financial institutions as such must not influence the decision of the board or nominate
any members to the board. However, this is allowed in case of term lending associations
in order to protect the interests of creditors.
16. A certificate from auditors on compliance should form part of the Annual report and
Annual return. A copy of the same must be sent to the Stock Exchanges.
17. This committee was set up under SEBI.
1. The full board must meet atleast 6 times a year with an interval of 2 months between
each meeting.
2. A listed company with a turnover of Rs. 1 billion must consist of competent and
independent non-executive directors who must form 30% of the board if the chairman is a
non-executive director and 50% of the board incase the chairman is an executive director.
3. No single person should hold directorships in more than 10 companies.
4. Non-executive directors must play an active role and must have defined tasks.
5. The non-executive directors must get a commission of 1% of the net profits incase
there is an MD or 3% incase there is no MD. They must also be offered stock options.
6. While reappointing members, the resolution being put to vote must specifically
mention instances when directors were absent for half or more than half of the meetings.
7. The following information must be placed before the board- (only 5 mentioned)
(a) Annual operating plans and budgets.
(b) Capital budgets, manpower and overhead budgets.
(c) Quarterly results for the company as a whole or its various business segments.
(d) Internal audit reports including material cases of theft and dishonesty.
(e) Details of any joint venture or collaboration agreement.
8. Listed companies which have a turnover of 1 billion or a paid up capital of 200 million
must set up audit committees consisting of atleast 3 members all drawn up from the
company’s non-executive directors who are financially literate within 2 years.
9. Audit committees must assist the board in its task related to corporate accounting and
provide effective supervision of the financial reporting process.
10. The audit committee must interact with statutory and internal auditors to ascertain the
quality of the company’s accounts as well as the capability of the auditors themselves.
11. The management must ensure that the committee has full access to the financial data
of the company, its subsidiaries and associated companies.
12. Listed companies must provide information about high and low monthly averages of
share prices in a major stock exchange where the company was listed in the reporting
year.
13. Major Indian companies must ensure that their company issues a compliance
certificate signed by the CEO and CFO which must clearly state that the company has
presented a fair picture in the financial statement and annual report.
14. For all companies with a paid up capital of 200 million or more, the quality and
quantity of disclosure that accompanied a GDR issue must be the norm for any domestic
issue.
15. Government must allow more funding towards the corporate sector against the
security of shares and other paper.
16. Financial institutions as creditors must not have nominee directors on the company
except in case of serious debt defaults.
17. If any company went to more than 1 credit rating agencies, it must declare the rating
given by all of them in its prospectus and issue document.
18. Companies making foreign debt issues cannot have exhaustive disclosure norms for
foreign entities and a miniscule one for the Indian entities.
19. Companies which defaulted on fixed deposits must not be allowed to accept further
deposits and make inter corporate loans or investments until the default is made good.
20. Financial institutions must take a policy decision to withdraw from boards of
companies in which their individual shareholding was 5% or less or where their total
holdings was under 10%.
21. This report didn’t have any legal backing and hence lacked enforceability.
1. Non-executive directors must be exempted from various civil and criminal liabilities.
2. There must be not less than 50% of independent directors and they must be made
responsible.
3. If the board consisted of 7 members, atleast 4 must be independent directors.
MANDATORY RECOMMENDATIONS
1. Disclosure of Contingent Liabilities
2. Management should provide a clear description in plain English of each
material contingent liability and its risks, which should be accompanied by the
auditor’s clearly worded comments on the management’s view. This section
should be highlighted in the significant accounting policies and notes on
accounts, as well as, in the auditor’s report, where necessary.
3. This is important because investors and shareholders should obtain a clear view of
a company’s contingent liabilities as these may be significant risk factors
that could adversely affect the company’s future financial condition and results of
operations.
4. For all listed companies, there should be a certification by the CEO (either
the Executive Chairman or the Managing Director) and the CFO (whole-time
Finance Director or other person discharging this function) which should state
that, to the best of their knowledge and belief: They have reviewed the balance
sheet and profit and loss account and all its schedules and notes on accounts, as
well as the cash flow statements and the Directors’ Report; These statements do
not contain any material untrue statement or omit any material fact nor do they
contain statements that might be misleading; These statements together present
a true and fair view of the company, and are in compliance with the existing
accounting standards and / or applicable laws / regulations;
5. They are responsible for establishing and maintaining internal controls and
have evaluated the effectiveness of internal control systems of the company; and
they have also disclosed to the auditors and the Audit Committee, deficiencies in
the design or operation of internal controls, if any, and what they have done or
propose to do to rectify these;
6. They have also disclosed to the auditors as well as the Audit Committee,
instances of significant fraud, if any, that involves management or employees
having a significant role in the company’s internal control systems; and
7. They have indicated to the auditors, the Audit Committee and in the notes on
accounts, whether or not there were significant changes in internal control and / or
of accounting policies during the year.
8. All audit committee members shall be non-executive directors
Non-mandatory recommendation
1. Companies should be encouraged to move towards a regime of unqualified
financial statements. This recommendation should be reviewed at an
appropriate juncture to determine whether the financial reporting climate is
conducive towards a system of filing only unqualified financial statements.
2. It also observed that the process of Board review of business risks will
be a mandatory recommendation of the Committee. Therefore, training
of Board members could be made recommendatory
3. Companies should be encouraged to train their Board members in the business
model of the company as well as the risk profile of the business parameters of the
company, their responsibilities as directors, and the best ways to discharge them.
4. The performance evaluation of non-executive directors should be by a peer
group comprising the entire Board of Directors, excluding the director being
evaluated; and Peer group evaluation should be the mechanism to determine
whether to extend / continue the terms of appointment of non-executive
directors.
The Committee noted that the definition of independent directors should be clarified in
the recommendations. It observed that the definition of independent directors as set out
in the code of the International Corporate Governance Network may be referred to.
The Committee also noted that the Naresh Chandra Committee report has attempted
to define the term “independent director”. The Committee was of the view that the same
definition may be used to define independent directors.
The term “independent director” is defined as a non-executive director of the company
who: Apart from receiving director remuneration, does not have any material
pecuniary relationships or transactions with the company, its promoters, its senior
management or its holding company, its subsidiaries and associated companies; is not
related to promoters or management at the board level or at one level
3. Directors may also have to hold qualification shares which can’t exceed Rs. 5000
unless the nominal value of each share of the company is Rs. 5000 or more. However,
this is not applicable to nominee directors. If such qualification shares are not mentioned
in the AoA, the company need not comply with it.
4. All directors put together form the board of directors. The different types of boards
are-
(a) Constitutional board- Such a board is set up due to statutory requirements. Generally
1 person is all powerful.
(b) Consultative board- It is where there is consultation amongst all board members
though a single person might emerge as being an autocrat. It may have evolved from a
constitutional board.
(c) Collegial board- This is when the entire board is in harmony and there is a lot of
consultation.
5. The maximum number of members of every board must be left to the company and the
same must be stated in its AoA. Generally a larger board is considered to be more
efficient.
6. The advantages of having a large board are-
(a) Diverse opinions may be taken into consideration.
(b) It prevents autocracy.
8. Special committees may also be constituted under the board to take decisions on behalf
of the board. Such committees must always report to the board and the AoA must
mention about their size, composition, etc. However, such committees may also become
very powerful and take over the board or become individual power pockets within the
company. Nevertheless, their expertise is also required. Further, there would be proper
allocation of responsibilities.
2.5.2 Importance of Independent Directors on the Board of Directors and their role
10. It has been suggested that a board must consist of independent monitors, mediators
and managers. The monitors are necessarily disinterested unaffiliated persons. The
managers are essentially employees of the company and are those most closely related to
the company. The mediators on the other hand are affiliated with the company but help
reconcile the interests of the other 2 groups.
11. However, there are certain limitations to this model. First, it is not known whether the
monitors are actually completely independent.
12. There has been a mention about independent directors in the Cadbury Committee
report, the Kumarmangalam Birla Committee report, the Naresh Chandra Committee
report, clause 49 of the listing agreement, etc.
13. An independent directors’ term cannot exceed 9 years. Once removed or once he
resigns, he must be replaced within 180 days.
1. Under S.209, the company must prepare annual accounts, profit and loss accounts and
balance sheets which must be presented in the AGM s.
2. It instills confidence amongst shareholders and leads to transparency.
3. Financial institutions also inspect such accounts.
4. The annual accounts are prepared by the internal employees and are later checked by
the auditors.
5. The board must also prepare the board’s report on such accounts.
6. External auditors are generally appointed by the directors or in an AGM. Internal
auditors are the employees of a company but even they should be independent.
7. The Sarbanes Oxley Act, 2002 defines audit as-an examination of financial statements
of any issuer by an independent public accounting firm in accordance with the rules of
the board or commission for the purpose of exercising an opinion on such statements.
8. External auditors examine such statements on the basis of generally accepted auditing
and related standards.
9. An auditor as per the Companies Act must be appointed within a month from the
incorporation of the company and holds office till the first AGM and may be reappointed.
10. Ordinary matters are such matters with respect to which the company need not give
an explanation in the AGM such as the appointment of directors, declaration of
dividends, etc.
11. The primary role of auditors is to prevent mismanagement.
12. Threats to the independence of auditors may be stated as follows-
(a) An auditor having personal interest in the company.
(b) When an auditor has taken a huge loan from the company or a director.
(c) If the auditor is largely dependent on client firm due to fees receivable.
(d) Potential employment with Client Company. Generally, a 2 year cooling off period is
recommended.
(e) Close business relationship
(f) Familiarity
(g) Intimidation by company
13. Even incase of independent directors, it has been recommended to keep them for 3
years because of such threats of familiarity.
14. Read Caparo Industries v. Dickman
15. As per S.224 (3), if auditors are not appointed in AGM s, the centre may appoint
them or may fill any gaps.
16. When either the central government or financial institutions hold 25% stake in the
company, their permission is required before auditors may be appointed.
1. SEBI came up as an administrative body in 1988. The SEBI Act was passed and the
SEBI board was created in 1992.
2. Some of its main functions include-
(a) Development of the securities market.
(b) Regulation of the securities market.
(c) Provide investor education.
(d) Regulating market intermediaries- These regulations say as to when one can be a
market intermediary.
(e) Prevention of insider trading.
(f) Regulation of substantial acquisition of shares.
3. SEBI derives power from S.11 of the SEBI Act.
4. It has come up with an insider trading regulation and a takeover code.
5. Insider trading is forbidden as such. Only one school in the US says that it must be
allowed as it would make the markets better. However, the Securities Exchange
Commission in the US has not accepted the same.
6. In India, SEBI came up with an insider trading regulation in 1992 punishing a defaulter
with 25 crores fine or 3 times profit a person has made in the entire process whichever is
higher.
7. However, this is very difficult to prove.
8. The 2002 amendment defined as to what is unpublished price sensitive information.
9. SEBI also came up with a takeover code in 1997. Regulations 10, 11 and 12 of this
code talk of public announcement to be made by a person who crosses the threshold limit
of shares and purchases more shares. Hence, there is an element of fairness involved.
MANDATORY REQUIREMENTS
I. BOARD OF DIRECTORS
C. Other Provisions
i) The Board shall meet 4 times a year with a maximum gap of 4 months
between two meetings.
ii) A director shall not be a member of more than 10 committees or act as a
chairman in more than 5 committes across all companies where he is a director.
iii) All information regarding committee positions of the director and changes
therein shall be made available to the company
D. Code of Conduct
i) A code of conduct shall be laid out for all Board members and the
management and posted on the website
ii) All members of the Board and senior management shall comply with the
code and this shall be reported in the Annual reports signed by the CEO
i) They shall meet 4 times a year and not more than 4 months shall elapse
between 2 meetings.
ii) The quorum shall be 2 members or 1/3rd which is greater.
iii) There should be a minimum of 2 independent directors present
III. DISCLOSURES
V. COMPLIANCE
I. THE BOARD
i) A NED may be entitled to maintain an office at the company’s expense and
will be entitled to a reimbursement of any expenses incurred in the course of
business
ii) Independent directors cannot have a tenure exceeding 9 years
iii) Independent directors should have the requisite qualifications and experience
to be of use to the company and perform effectively
Finance:
It is the art or science of managing money.
1. Financial service
2. Financial management (FM)
Financial Management:
It deals with the functions of a financial manager.
It deals with:
• Procurement of funds
• Effective utilization of the same in business
Approaches to FM:
Traditional Approach:
In 1950s and 60s, it was a narrow approach. It said that FM deals with the procurement of
funds from corporates.
(i) But it is not only corporates who need funds but even non-corporates
(ii) It only talks about procurement
What after that? What about day to day management of financial capital? Therefore it is
seriously criticized.
Modern Approach:
It involves 3 questions:
(i) It talked about capital structure- what is the total value of funds a company
requires?
(ii) What specific assets should an enterprise have?
(iii) How should the funds required be financed?
To answer these questions, the modern approach talks of 3 decisions a finance manager
needs to make:
• Investments
• Finance
• Dividends ( amt of profits for shareholders)
II. Dividend:
Owners expect something from the co.
The dividend is not a company’s expenditure.
It just pays back its owners.
A dividend comes in after paying income tax.
Therefore, it is the costliest source of funds as their must be sufficient funds to pay back
the shareholders.
Extra info:
The basic structure of finance side includes sale, expenses, income and dividend.
• Very costly source of fund
• A dividend can only be paid back if there are profits. Some companies adopt a no
mandatory requirement of payment of dividends, even if there are profits.
ES capital and preference equity are 2 ways of getting investments through shares. The
ESH s have the least risk involved as you don’t have to pay them back.
2. Preferential Equity:
Preferential SH s are not actual owners of the co.
They get preference pmt of dividends.
• Get preference over equity SH s
• Not owners of the co.
• When co winds up, first preference is given to them
• They have to be appointed as they are not owners. Their SH s have to be
converted to equity share or redeemed.
• The preferential SH s get dividend only when the co starts making profits but
also in the previous yrs when it has made losses.
• Generally companies don’t opt for preferential SH s
Equity SH doesn’t have the right to come to a co and demand pmt, either the principal
amt or dividend. Therefore, a co faces lesser risks if it asks for equity, instead of
approaching a bank for a loan.
3. Debentures:
These are loans issued from financial institutions.
Debentures are easier to get than loans as there are lesser conditions involved and
financial institutions give loans more willingly as they look into the practicability of
things and they are interested in getting returns from such loans.
This is also done as it becomes very different to always go to the public and issue equity
SH s.
Also, tax liability on dividends is very high
Features:
• Cost of capital for raising debentures is quite low- lot of capital is nt required.
One can just go to financial institutions.
• Secured against assets- collateral securities required to be made to get loans. This
is mainly because debenture holders are not co owners.
• No dilution of control- incase of issuing equity SH s some persons may have more
shares than the rest and thus control changes. But if debs are issued, such
debenture holders are not owners. Thus, the ownership and control of co remains
the same.
• Obligation of making pmts on a regular basis- pmts need not be made to equity
shareholders on a regular basis and only to be paid during times of profit. Deb
holders to be paid principal and interest. If interest not paid on time then there will
be interest on interest.
• Results in increased financial risk for co- this is mainly because the co is to pay
on a regular basis. When the co goes for a wind up, the 1st priority is given to debs
as they give loans. Deb mainly accepted on a long term basis.
• Den are also convertible- if a co is not in a position to pay interest, they will ask
the fin institutions to charge a lower interest and convert their debentures into
equity shares within a given time period.
I. Trade Creditors:
• Credit granted by the supplier of goods- a credit period given between 60-90
days is specified. The money is utilized within the certain time limit. There is no
interest involved and thus no cost.
• It is a source of finance without any explicit cost- this system is generally
followed in India.
• Amount of trade credit increases with increase in volume of business- by
increase in volume of purchases more money is kept within the same period of
time.
Very important for a finance manager to secure funds in such a manner, to have
sufficient funds to pay off liabilities.
With time, the purchasing power etc of money reduces. Therefore, instead of
investing / utilizing funds, if a FM helps the money in the bank to pay off the
liabilities, the time value of money will depreciate.
Definition: Time value of money means worth of a rupee recd today is different
from worth of one rupee recd tomorrow.
An FM needs to keep a specific amt of funds in mind and the reqd returns.
COMPOUNDING:
Compounding means finding the future value of present money
Unless specified, interest is always paid per annum
Single cash flow- only a single investment
DISCOUNTING:
Discounting means the present value of future money
P.V = F.V
(1+R/100)N
QUESTIONS:
1. The present value of money is Rs. 1000 with 5% rate of interest p.a. for 3 yrs.
Find out the future value.
2. The present value of money is Rs. 60000 for 5 yrs at 12% p.a. find out
• F.V
• Will there be any difference if the same compounding is done half yearly?
= 60000 (1+12/200)5 x 2
= 60000 (1+6/100)10
= 60000 (1+106/100)10
= Rs. 1,07,450.86
3. present value is Rs. 3000 for 9 yrs at 12%p.a. find out about the future
value.
4. present value is Rs. 1,00,000 at 10% p.a and future value is 1,21,000. wat is
the number of yrs?
6. In the above question will it make any difference if he invests at the end of the year
instead of the beginning of the year? (Discounting question)
1. You need Rs10,000 to buy a book next yr. you can earn 7% on your money. How
much will u invest today?
P.V = 10000 / (1+ 7/100)1
= 9345.79
2. what is the PV of income stream which provides Rs1000 at the end of the first yr, Rs.
2500 at the end of the 2nd yr and Rs. 5000 each at the end of yrs 3-10, if discounting rate
is 12%.
D.F = 1/ (1+r)n
F.V YRS D.F P.V (f.v * d.f)
1000 1 0.8929 892.9
2500 2 0.7971 1992.75
5000
For 5000 – 5000 * add discounting factors frm yr 3-10
= 5000 * 3.9598
= 19,799
Total P.V= 892.9 + 1992.75 + 19799
= 22,684.65
3. Assume deposit is to be made at yr 0, considering it will earn 8% compound interest
annually. It is desired to withdraw 5000, 3 yrs from now and 7000, 6yrs from now. What
is the size of the deposit at year 0, which will provide for these future values? ( not
answered)
5. X borrowed 5, 00,000 at 14% p.a repayable in 5 equal installments payable at the end
of the yr. find out:
i) Total sum payable to the bank
ii) Will it make any difference if 1st installment is to be made at the end of the 2nd yr.
(answer in Bhoomika’s notes)
Current assets: funds which are received or receivable in one year. Eg:
Debtors / promissory notes
Gross working capital: Investment in all current assets of the company (total
current assets)
Net working capital: it refers to excess of total current assets over liabilities.
Permanent working capital: Minimum amount of money that the business has
to maintain at each point of time.
Temporary working capital: Working capital cycle refers to the length of time
between the point from which a firm pays cash for raw material, enters into
production process and receives cash from debtors.
A company holds raw materials on an average of 60 days. It gets credit of 15 days from
its suppliers. Production process further needs 15 days. Finished goods are held for 30
days and 30 days credit is extended to debtors.
= 60 – 15 + 15 + 30 + 30 = 120
The operating cycle consists of the following events which continue throughout the life
of business:
1) Conversion of cash to raw material
2) Conversion of raw material into work in progress
3) Conversion of work in progress into finished goods
4) Conversion of finished goods to accounts receivable throughout sale
5) Conversion of accounts receivable to cash
FORMULAS NEEDED:
1) Raw material storage period = Avg stock of raw material
Avg cost of raw material consumption per day
• Avg stock of raw material means the value of the raw material
• WIP is the raw material and add additional costs which include labour cost and
other administration costs. This total cost is known as cost of production.
• COGS means the entire cost incurred from the time the raw material bought till
the finished goods are sold.
• Avg credit sales per day are how much you sell to the debtors.
• Avg credit purchases per day are how much you purchase from creditors.
Working capital mgmt mainly focuses on how long funds or cash are locked in.
Factors to be taken into consideration while determining WC are:
1) Production policy: In a seasonal industry the WC is required during a specific
period when production takes place. Eg: mango pickle industry
2) Nature of business: shorter the manufacturing process, shorter the WC blockage
3) Labour intensive/ machine intensive organization: funds are blocked for longer in
labour intensive and capital in machine intensive
4) Credit policy: liberal credit policy allows debtors a longer period and the WC
cycle increases
5) Inventory mgmt: 2 inventories: raw material and finished goods. FG can be
managed by looking at market factors while RM can be managed by using a few
basic theories.
6) Abnormal factors: like strikes and lockouts- this increases the finished stock
holding period
7) Market conditions: in a market where there is tough competition, one has to work
towards immediate delivery of goods
8) Growth and expansion: growth of co leads to increase in WC
9) Dividend payment policy: such payment leads to cash outflows and thus WC
needs to be managed
10) Tax payment: Advance taxes need to be paid as well as this affects the WC
MANAGEMENT OF CASH:
INVENTORY MANAGEMENT: