JAIIB AFM Module-C Unit 1 : Financial Management – An Overview

JAIIB Paper 3 AFM Module C Unit 1 : Financial Management – An Overview (New Syllabus)

IIBF has released the New Syllabus Exam Pattern for JAIIB Exam 2023. Following the format of the current exam, JAIIB 2023 will have now four papers. The JAIIB Paper 3 (Accounting and Financial Management for Bankers) includes an important topic called “Financial Management – An Overview”. Every candidate who are appearing for the JAIIB Certification Examination 2023 must understand each unit included in the syllabus. In this article, we are going to cover all the necessary details of JAIIB Paper 3 (AFM) Module C (FINANCIAL MANAGEMENT ) Unit 1 : Financial Management – An Overview Aspirants must go through this article to better understand the topic, Financial Management – An Overview, and practice using our Online Mock Test Series to strengthen their knowledge of Financial Management – An Overview. Unit 1 : Financial Management – An Overview

Introduction

• When the business is started, the owners bring funds in the form of capital.
• It has to raise further funds in the form of further issue of capital and borrowings.
• The funds are needed for creating the fixed assets as well as for the working capital.
• How these funds are used most efficiently is also important.
• The financial activities of a business organisation mainly relate to its assets, liabilities and revenues.
• Planning, organizing, conducting and controlling all these financial activities of the organisation is the function of Financial Management.

Forms Of Business Organisation

• The form of a business organisation is the choice of the owners/promoters.
• A business organisation may have any of the following forms:

Sole Proprietary

• Owned and run by one person

• There is no legal distinction between the owner and the firm.
• The business owner is referred to as the sole proprietor.
• He/she exclusively owns all the assets and profits of the business.
• The profit of the firm is taxed as personal income of the proprietor.

Advantages:

• Subject to minimum regulations.
• Simplest form of a business organisation.

Limitation:

• Limited capital as the resources of the proprietor are limited

Partnership Firm

Partnership is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.

• Governed by the Indian Partnership Act, 1932.
• As per Section 4 of the Indian Partnership Act

From this definition, the following points are clear: 

• An association of two or more persons
• An agreement/contract between the persons
• The agreement is to carry on a business with the object of sharing profits
• The business is to be carried on by all or any of them acting for all.

• The persons involved in the agreement are called partners and the entity created for the business is called partnership firm.
• LIABILITY of each partner is unlimited unlike a Limited Liability Company (LLC).
• Maximum member: The Indian Partnership Act does not mention anything but as per the Companies Act 2013 and The Companies (Miscellaneous) Rules, 2014, a partnership can have a maximum of 50 persons.
• A company can also be a partner in a partnership firm.
• The partnership firm may be registered but it is not mandatory.
• A partnership has no separate legal status apart from its partners

Limited Liability Partnership (LLP)

• It is a newly established concept introduced in India by Limited Liability Partnership Act, 2008.
• A Limited Liability Partnership (LLP) is a partnership in which some or all partners have limited liabilities.
• It therefore has elements of partnerships as well as Limited Liability Companies.
• Registration: With Ministry of Corporate Affairs while registration of a partnership firm is done with Registrar of Firms.
• Legal Entity: An LLP is a legal entity unlike a partnership firm which has no separate legal status apart from its partners.
• In LLP, one partner is not liable for the acts of another partner.

Hindu Undivided Family (HUF)

• Exists only in India and is governed by the provisions of the Hindu Law.
• It is different from a partnership firm as it comes into existence not out of any contract but birth in a Hindu family.
• The firm is owned by the members of undivided Hindu family, called co-parceners.
• Typically managed by the senior-most male member, also known as Karta or Manager.
• For the sake of income tax, the HUF is considered as a separate entity and is taxed separately

Association of Persons or Body of Individuals

• Association of Persons (AOP) means a group of persons, whether incorporated or not, who come together for achieving a common objective.
• Members of the AOP can be natural or artificial persons.
• Body of Individuals (BOI) means a group of individuals (natural persons), whether incorporated or not, who join together for earning income.
• Both AOP and BOI are treated as separate entity for the purpose of assessment under the Income Tax Act.

Company

• A company is an association of persons who contribute money or money’s worth to a common stock and use it for a common purpose.
• Created by law and effected by law.
• A legal person just as much as an individual but with no physical existence.
• Section 2 (20) (Chapter I) of the Companies Act, 2013, defines a company as – A company incorporated under this Act, or under any previous Company law.
• Companies Act 2013 also permits formation of “One-Person Company” which has only one person as its member.

Co-operative society

• This can also be one form of a business organisation.
• It is a form of business where individuals join hands for the promotion of their common goals.
• Main objective: Mutual assistance and service.
• A registered co-operative society is recognized as a separate legal entity by law.
• It acquires an identity quite distinct and independent of its members.
• It can purchase and dispose of its assets. It can sue, and also can be sued.
• The management of a co-operative society is vested in the management committee elected by the members of the society.

Financial Decisions In A Firm

Financial decisions in a firm mainly relate to the acquisition and utilization of capital funds in meeting the financial needs and overall objectives of the firm.

Therefore, the primary function of finance department is to acquire capital funds and put them to proper use, as per firm’s objectives. Financial decisions in an organisation, normally, relate to the following: 

• Estimating the capital requirements
• Deciding the capital structure/composition
• Deciding on sources of funds
• Use of long term funds
• Corporate strategy/mergers and acquisitions
• Use of short term funds/Working capital management
• Financial Control
• Compliance
• Decision of dividend/retained profit

Objectives Of Financial Management

The objectives of the financial management are to efficiently carry out all the functions mentioned above under scope of financial management. These objectives can be summarised as under: 

• To ensure adequate and timely supply of long and short term funds to the organisation, at reasonable cost.
• To ensure optimum utilization of funds
• To take sound capital investment decisions
• To decide on optimum capital structure
• To ensure statutory and regulatory compliance
• To ensure balance between shareholder benefits and organisational objectives
• To ensure appropriate financial risk-management system

Fundamental Principles Of Finance

While discussing the principles of finance, let us keep in mind that finance is not the same as money lending. Lending is just one constituent of finance. So, the principles of finance should not be confused with principles of lending.

The main principles of finance are as under:

• Time Value of Money
• Opportunity Cost of Money
• Risk and Return
• Liquidity and Return
• Diversification
• Reducing asset-liability mismatch/Hedging
• Cash flow

Building Blocks Of Modern Finance

Traditional approach: Finance functions consist of financial planning, raising of funds, allocation of funds, and financial control.

The modern approach considers that the corporate finance function is built up on the four basic blocks mentioned as under:

• Planning
• Decision making
• Organising and Directing
• Controlling

Risk-Return Trade Off

• The risk-return tradeoff means that the potential return rises when a higher risk is taken, and vice versa.
• Financial decisions of a firm are often guided by the risk-return trade off.
• Risk is inherent in every investment, though its scale varies.
• In order to increase the possibility of higher return, the firm needs to increase the risk taken and vice-versa
• Depending upon the risk-taking ability, investment objectives, and the time horizon available to achieve it, a firm has to find the optimal combination of risk and return in a financial  decision.
• A proper balance between return and risk should be maintained to get optimum return from the investment.
• Such balance is called Risk-Return Trade off and every financial decision involves this trade off.

Required Rate of Return 

• The firm has to decide on the rate of return it wants on its investment, below which it would not like to invest its money.
• The relationship between required rate of return and risk can be expressed as under:

Required Rate of Return = Risk-free Return + Risk Premium

• Various tools are used in financial management for measuring the risk. One of these is the Standard Deviation.
• Higher the risk, the higher the risk premium is, which pushes up the required rate of return.
• While the investment in Government bonds is considered to be risk free as the interest rate is known and the risk of default is almost nil, investment in junk bonds involves high risk because of high probability of default, though the yield is high due to low market rate

Business Ethics & Social Responsibility

• In general, ethics are concerned with classifying what is right and what is wrong.
• Business ethics: Focus on what is right for the shareholders and stakeholders.
• Drives the code of conduct of a company.
• Normally, each company has a well-documented code of conduct applicable to both the business and to its employees.
• Companies voluntarily adopt this code of conduct containing the principles of corporate ethics.
• These principles govern every aspect of the company’s dealings with government, other businesses, its employees, its customers and any other stakeholder.

• Social responsibility is different From business ethics as it focuses on the impact of firm’s business on the environment and community.

Importance of business ethics 

• A company’s perception in the eyes of stakeholders as well as the outsiders, is shaped by its business ethics.
• Helps in not only in raising resources for the expansion of the business but also makes it a preferred partner for doing business.
• Helps to attract the best talent in the industry: high productivity and low attrition rates.
• The customers of a business entity that treats them ethically, become repeat customers and build an ongoing relationship with the entity.
• These customers recommend that entity to the people within their contact.
• The brand value of an entity, known for its high ethical values, keeps growing and helps in increasing its market share

Principles of code of conduct/Ethics 

The code of conduct, adopted by an organisation, is affected by both the nature of the company’s business and its location. The broad principles of code of conduct or ethics, in business, can be mentioned as under:

• Personal responsibility
• Corporate responsibility
• Corporate Transparency
• Honesty
• Integrity
• Promise-Keeping
• Trustworthiness
• Loyalty
• Fairness
• Concern for Others
• Respect for Others
• Customer Prioritisation
• Law Abiding
• Community and Environmental Responsibility
• Data Protection
• Whistle-blower Protection
• Workplace Diversity and employee compensation

Emerging Role Of The Finance Manager In India

A finance manager of a firm deals with how the money is raised from investors, how that money is invested and how the investors are rewarded with suitable return on their investments.

The key areas in which changes are taking place, are as under: 

• Selection of project
• Raising Equity
• Raising debt
• Interest rate on debts
• Foreign exchange management:
• Treasury operations
• Coping with technological changes/data availability
• Dealing with Rating Agencies
• Investor communication

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JAIIB Paper 3 (AFM) Module C Unit 1 – Financial Management – An Overview (Ambitious Baba)

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