Management II New Short Note English PDF

Unit 1 1. Quantitative credit control Economic Environment for Management a. Bank Rate Policy 1 Economic Environment The bank rate...

Unit 1 1. Quantitative credit control Economic Environment for Management a. Bank Rate Policy 1 Economic Environment The bank rate, is the rate at which central bank would re-discount the eligible bills already discounted by commercial banks. The money supply in the Economic environment refers to the economic factors like economic country can be controlled by increasing or decreasing the bank rate. conditions, economic policies and economic systems that influence the business 1.Repo Rate in a country. This is the interest rate at which the central bank lends to commercial A. Economic system banks. Economic system is a system, which functions in a country for the 2.Reverse Repo Rate purpose of production and distribution of goods and services to satisfy the needs This is the interest rate given by RBI to banks for their deposit. of the people. Economic system can be; b.Open Market operation 1. Capitalism Capitalism is the private ownership of production and distribution. The central bank may purchase or sell the securities in the open market Production of goods and services is based on supply and demand in the market. and thereby control money supply in the economy. During inflation the central Eg: Singapore, New Zealand, Australia, Canada, Switzerland, UK,USA etc bank would sell the securities and purchase security on deflation. 2.Socialism c.Variable Reserve Ratio In a socialist economic system, production and distribution are owned Controls money supply by making suitable changes in SLR and CRR. and controlled by the government. SLR [Statutory Liquidity Ratio] Eg: China,Cuba, Vietnam, North Korea. Etc It is the minimum ratio of deposits that a bank must maintain in the form 3.Mixed economy of gold, cash or other recognized securities. A mixed economy is an economic system that is a combination of CRR [Cash Reserve Ratio]. capitalist economic system and socialist economic system. It includes both This is the minimum cash deposit that a bank must maintain with the private enterprises and public enterprises. RBI. Eg: France, Holland, India etc B. Qualitative credit control B.Economic Policy a. Margin requirements b. Moral suasion c. Direct action d. Credit-rationing Economic policy is intended to influence or control the behavior of the B.Fiscal Policy economy. Economic policies are implemented and controlled by the government. fiscal policy is concerned with the determination of State income and I. Monetary Policy expenditure policy. This is the policy, through which Government can encourage Monetary policy is concerned with the management of supply of money and restrict consumption, investment and saving habits in a country. It was in a country. The main objective of monetary policy is to maintain price stability popularized by J M Keynes. and ensure an adequate flow of credit to the productive sectors of the economy. Techniques of fiscal policy of India Monetary policy is announced by Central bank of a country. Monetary policy is 1. Taxation policy 2. Public expenditure policy 3. Public debt policy also termed as credit control policy. Credit control can be of two types. 4. Deficit financing policy 1.Quantitative credit control 2. Qualitative Credit control C. Foreign Trade Policy Determines the scope for trade between countries. 1 Reji Thomas T KMVHSS kodakkad 2 D. Licen ട ing Policy GNP = GDP + Net factor Income from abroad. Till 1991, India adopted licensing policy to regulate the growth of 4.Net National Product (NNP) industries in India. It is the total money value of all goods and services produced by the E. Technology Policy citizens of a country after deducting depreciation. The policy of using modern techniques in business. NNP =GNP – Depreciation. F. Price Policy Problems in estimating National Income Price policy controls the price of commodities in a country. Problems in calculating national income can be classified into two , Importance of Economic Environment namely statistical difficulties and conceptual difficulties. 1. Identifying opportunities and threats. 1. Lack of adequate statistical data. 2. Giving direction of growth. 2. Non-cash transactions are not taken into account. 3. Continuous learning. 3. Small producers do not keep records of their production. 4. Image building. 4. Classification is difficult as income comes from many sources. 5. There is a difficulty of avoiding double counting in calculations. 5. Meeting competition. 6. No accepted standard rate while calculating depreciation. 6. Identifying strength and weakness. 7. Changes in prices are not included in the calculation of national income. National Income Methods of Measuring National Income National income is the money value of all the final goods and services There are three methods of measuring national income: produced by a country during a period of one year. 1) Value added method or Product method Basic Concepts of National Income 2) Income method 1.GDP-Gross Domestic Product 3) Expenditure method 1. Product method/Value Added Method Gross domestic product is the money value of all final goods and services There are three steps in computing national income, under product method. produced in the domestic territory of a country during a year. Domestic territory a.Classify the economy includes:- i. Primary sector : Producing commodities by exploiting natural resources like 1.Territory lying within the political frontiers, including territorial waters of the country. land and water e.g. agriculture, forestry, fishing, mining etc. 2. Ships and aircrafts operated by the residence of the country. ii. Secondary sector: Manufacturing sector–transfers one type of commodity into 3.Embassies, consulates and military establishments of the country located another eg. manufacturing, construction, electricity, gas, water supply etc. abroad. iii. Tertiary sector i.e. service sector e.g. trade and commerce, transport and 2.NDP–Net Domestic Product communication, banking, insurance Government and professional services. Net domestic product is the money value of all final goods and services b. Estimation of net value added produced in the domestic territory of a country during a year after deducting At this stage, the combined net value of products and services in the depreciation. primary, secondary and tertiary sectors is calculated. NDP = GDP - Depreciation Value Added = Value of output -Intermediate consumption 3.Gross National Product (GNP) c.Estimation of National Income It is the total money value of all goods and services produced by the Gross National Product=Gross Value added+Net factor income from abroad citizens of a country. 2. Income Method 2 There are four steps in computing national income, under this method. 3 a.Classify the economy 1.Boom i. Primary sector : Producing commodities by exploiting natural resources like Boom is a period of business optimism. It is characterized by high land and water e.g. agriculture, forestry, fishing, mining etc. productivity, income, price and trade expansion. During this period Investment ii. Secondary sector: Manufacturing sector–transfers one type of commodity into Increases in the business, increases employment and demand for goods, but it is not sustainable. another eg. manufacturing,construction, electricity, gas, water supply etc. 2.Recession (Contraction) iii. Tertiary sector i.e. service sector e.g. trade and commerce, transport and Recession is a period of business pessimism. It starts with the stock communication, banking, insurance Government and professional services. market crash and some business failures. Unemployment and low incomes lead b.Classify factor incomes to a decline in overall demand. Classify factor income into employee compensation, capital income, and 3.Depression mixed income. During the phase of depression economic activity is at its low ebb. Wages, c.Estimating factor incomes costs and prices are very low. There is massive unemployment and a fall in the At this stage, the combined net factor income from the primary, aggregate income of the people. The lowest point at this phase is called ‘trough secondary and tertiary sectors is calculated. 4.Recovery d.Estimating net factor income from abroad Depression phase does not continue indefinitely. The idle workers now Gross National Income = Gross Factor Income + Net factor income from abroad come forward to work at low wages, consumers start consuming, and banks come forward to give loans. Thus economic activity starts picking up. 3.Expenditure Method The expenditure method estimates national income by measuring final expenditure on gross domestic product. Final expenditure in an economy is the sum total of the expenses incurred on final goods and services produced. It is the sum total of consumption expenditure and investment expenditure. The final expenditure on gross domestic products consists of: a. Private final consumption expenditure b. Government final consumption expenditure c. Gross fixed capital formation d. Changing stocks e. Net acquisition of valuables f. Net export of goods and services Business cycle/Trade cycle Economic activities never move on a straight line, it faces fluctuations. The fluctuation in the level of economic activity is called business cycles. It is characterised by the periods-boom, recession, depression and recovery. Business cycle affects the total income, investment, employment and output. 3 Reji Thomas T KMVHSS kodakkad  4 Unit 2 Components of Working Capital Working Capital Management A Current Assets: Current assets are the assets that can be converted into cash within a year. Investment in fixed assets is called fixed capital and investment in Current assets include: current assets is called working capital. Funds needed for the day to day a) Inventory i. Raw materials ii. Work-in-progress iii. Consumable stores requirements of business are known as working capital. iv. Finished goods Importance of Working Capital b) Sundry debtors c) Bills receivables d) Pre- payments 1. Ensures uninterrupted flow of production. e) Short term investments f) Accrued income g) Cash and bank balances 2. Enables a business to make prompt payments. B. Current liabilities: 3. Enhance the goodwill of the firm Current liabilities are the liabilities payable within one year. 4. The business can make cash purchases and thereby avail cash discount. Current liabilities include: 5. Helps the firm to exploit favorable changes in the market a) Sundry creditors b) Bills payable c) Accrued expenses d) Bank overdrafts 6. Enable the firm to face crisis. e) Proposed dividends f) Short term loans g) Tax payments due 7. Creates an atmosphere of security, confidence and high morale. Factors determining the working capital requirements Concepts of Working Capital 1.Nature of the business 1.Gross Working Capital The working capital requirements of a firm depend on the nature of its The sum total of all current assets of a business is called Gross working business. Organisations such as electricity, water supply and railways require capital. very limited working capital. But trading and financial institutions require large Gross Working Capital = Total Current Assets investments in current assets. 2. Net working capital 2. Size of the business Net working capital is the difference between current assets and current Larger the size of a business unit, the larger is the working capital liabilities. requirements. Smaller firms require less working capital. Net Working Capital=Current Assets-Current Liabilities 3.Production Policy Positive Working Capital=Current Assets-Current Liabilities Companies that collect more inventory need more working capital to Negative Working Capital=Current Liabilities- Current Assets maintain production stability. 3.Permanent or Fixed Working Capital 4. Length of production cycle The minimum level of current assets continuously required by the In the production business, the requirements for working capital increase enterprise to carry out its normal business operations is called fixed working in proportion to the length of the production process. capital 5. Working capital cycle 4. Temporary or variable working capital The working capital cycle begins with the purchase of raw materials and This is the amount of working capital which is required to meet the ends with the sale of finished products. The longer the cycle, the greater the need seasonal demands and some special exigencies. for working capital. 5.Zero Working Capital 6. Stock turnover rate Current Assets-Current Liabilities=0 A company with a high rate of stock turnover needs less working capital compared to a company with a low turnover rate. 4 Reji Thomas T KMVHSS kodakkad 5 7. Credit policy 2. The firm cannot avail the benefit of bulk purchase and discounts. A company that purchases on credit and sells goods for cash needs less 3. The firms cannot exploit favorable market condition. working capital. But more working capital is needed when buying goods for cash 4. The firm cannot pay the day-to-day expenses of its operations. and selling them to customers on credit. 5. The firm cannot maintain the fixed assets properly. 8. Business Cycles 6. The rate of return on investment also falls. During periods of boom, large amounts of working capital are required, Approaches to Working capital but during periods of recession a small amount of working capital is required. There are two sources for financing working capital requirements: 9. Growth rate of business a. Long term sources- Working capital requirements increase with the growth of business Share capital, debentures, public deposits, plough back of profits, loans operations. Fast- growing companies need large amounts of working capital. from financial institutions etc. 10. Dividend policy b. Short term sources- A company that maintains a cash dividend and a consistently high rate Short term fund from commercial banks, indigenous bankers, trade will require more working capital than firms that maintain a large portion of creditors, installment credit, advances, accounts receivables etc. profits. There are three basic approaches for determining the mix to finance 11. Price changes working capital. They are: The rising prices will require the firm to maintain larger amount of 1.Conservative approach working capital to maintain the same level of current assets. According to this approach, the total investment in current assets should 12. Other factors be raised from long-term sources. Operating efficiency, management ability, irregularities of supply, import Features policy, importance of labour, banking facilities etc., also influence the requireme a) Liquidity is high b) Reduces risk nts of working capital. c) The financial cost is relatively high Working Capital Management 2. The aggressive approach Working capital management means planning, organising directing and According to this approach, the total investment in current assets should controlling of working capital. It is concerned with the management of current be raised from short-term sources. assets and current liabilities of a firm in such a way that a satisfactory level of Features working capital is maintained. a) Higher risk b) Less cost c) Higher profit Dangers of excessive working capital 3. The hedging or matching approach 1. Idle funds earn no profits for the business. The hedging approach suggests that the permanent working capital 2. Accumulation of inventories causing more chances of theft, waste and losses. requirements should be financed from long term sources while the temporary or 3. Defective credit policy cause higher incidence of bad debts. seasonal working capital requirements should be financed with short term funds. 4. Due to low rate of return on investments, the value of shares may fall. Working Capital Cycle 5. The redundant working capital gives rise to speculative transactions. In terms of production, the working capital cycle starts with the purchase Dangers of inadequate Working Capital of raw materials and ends with the sale of finished products to raise money. 1. Firm cannot pay its short term liabilities in time. This will lose its reputation Cash→Raw Material→Work in Progress→Finished goods →Sales →Debtors 5 Reji Thomas T , KMVHSS kodakkad  6 Unit 3 chooses that project which maximises the shareholders’ wealth. Long Run Investment Decision – Capital Budgeting 4. Project Execution The investment decision relating to the long term or fixed assets is Once the selection is made, the project will be implemented by acquiring known as capital budgeting or capital expenditure decision or long term necessary funds for financing the project. investment decision. The capital expenditure may be; 5. Feedback- Cost of acquisition of fixed assets. After the execution of the project, its progress must be monitored with Cost of mechanization, automation and replacement. the help of feedback reports. Actual performance should be compared with the Investment on research and development expected one and deviations, if any, should be properly addressed. Cost of development and expansion of existing and new projects. Methods of Capital Budgeting Importance of capital budgeting Non-Discounted Cash Flow Methods (Traditional Methods) 1. Cost Payback Period (PBP) Accounting Rate Of Return (ARR) Initial investment is huge. Hence, these decisions are planned after Discounted Cash Flow Methods (Modern or Time adjusted Methods) careful evaluation of various projects. Net Present Value (NPV) Profitability Index (PI) 2.Time Internal Rate of Return (IRR) The effect of the decision is known only in the near future and not immediately. a) Payback Period (PBP) 3.Irreversibility PBP is the number of years required to recover the original cash outlay These decisions once taken are not easily reversible without incurring huge loss. invested in a project. a) When the annual cash flow is constant- 4. Risk PBP=Initial Investment/Constant Annual Cash Inflow The longer the time period of returns, the greater is the risk. Hence If an investment of 100000 in a machine is expected to generate cash decisions should be taken after a careful review of all available information. inflow of 20,000 per annum for 10 years. Calculate PBP 5. Complexity PBP =Initial Investment/Constant Annual Cash Inflow Decisions are based on forecasting of future events and inflows. PBP =100000/ 20000 =5 Years Quantification of future events involves application of statistical techniques. b) b)when a project’s annual cash inflows are not equal Capital Budgeting Process A firm requires an initial cash outflow of 20,000 and the annual cash inflows for 5 years are 6000,8000, 5000, 4000 and 4000 respectively. Calculate PBP. 1.Identify the Investment Projects - Answ: The first step of any investment decision is to identify the opportunities. PBP= Year Cash Cumulative Several opportunities are available for investment but only promising 3 Years+4000x(1000/4000)x12 = Inflows Inflows opportunities that are compatible with firms objectives should be identified. 3 Years and 3 Months 1 6000 6000 2. Evaluate the Investment Projects It is necessary to estimate inflows and out-flows of each of the 2 8000 14000 investment projects. Evaluations are done by using different capital budgeting 3 5000 19000 techniques. 4 4000 23000 3. Select Investment Project 5 4000 27000 After considering returns, risk and the cost of capital, top management 6 Reji Thomas T , KMVHSS kodakkad 7 Decision Rule: cash inflows and the present value of cash outflows. * If the PBP is less than the acceptable payback period, accept the project. Computation of NPV * If the PBP is greater than the acceptable payback period, reject the project. 1. Annual cash flows of the investment project should be forecasted. Advantages 2. Appropriate discount rate should be identified to discount the cash flows. 1. This method is simple to calculate and easy to operate. 3. Present value (PV) of cash flows should be calculated by multiplying with 2. It is suitable in the case of industries where the risk of technological appropriate discount rate. obsolescence is very high. 4. Find NPV, NPV= Present Value of Cash inflows -PV of Cash Outflows 3. It clarifies the concept of profit or surplus. Decision Rule: 4. When funds are limited projects having shorter payback should be selected. *If the NPV is greater than 0, accept the project. Limitations * If the NPV is less than 0, reject the project. 1. It stress on capital recovery rather than profitability. Advantages 2. It does not consider post payback cash flows. 1. It considers the concept of time value of money. 3. This method ignores time value of money 2. All cash flows are considered. Limitations b) Accounting/Average Rate of Return(ARR) 1. It involves complex calculations in discounting and present value calculations. It is also called Return On Investment (ROI), Return On Capital Employed 2. It ignores the difference in initial cash outlays, size of different proposals etc. (ROCE) Average Annual Profit after Tax b) Profitability Index (PI) ARR= x 100 Profitability Index (PI) or Benefit-cost ratio (B/C) is similar to the NPV Average Annual Investment Decision Rule: approach. *If the ARR is higher than the minimum rate , accept the project PI = Total discounted Cash inflows/Initial cash outlay * If the ARR is less than the minimum rate , reject the project. Decision Rule: Discounted Cash Flow Methods * Accept the project when PI>1 a) Net Present Value (NPV) * Reject the project when PI