Good capital budgeting will also improve the timing of asset acquisitions and the quality
of assets purchased. This situation follows from the nature of capital goods and their
producers. Firms do not order capital goods until they see that sales are beginning to
press on capacity. Such occasions occur simultaneously for many firms. When the
heavy orders come in, the producers of capital goods go from a situation of idle
capacity to one where they cannot meet all the orders that have been placed. Consequently,
large backlogs accumulate. Since the production of capital goods involves a relatively
long work-in-process period, a year or more of waiting may be involved before the
additional capital goods are available. This factor has obvious implications for purchasing
agents and plant managers.
Asset expansion is fundamentally related to expected future sales. A decision to buy
or to construct a fixed asset that is expected to last five years involves an implicit fiveyear sales forecast. Indeed, the economic life of a purchased asset represents an
implicit forecast for the duration of the economic life of the asset. Hence, failure to
forecast accurately will result in over investment or under investmnent in fixed assets.
An erroneous forecast of asset requirements can result in serious consequences. If the
firm has invested too much in assets, it will incur unnecessarily heavy expenses. If it
has not spent enough on fixed assets, two serious problems may arise. First, the firm’sequipment may not be sufficiently modern to enable it to produce competitively. Second,
if it has inadequate capacity, it may lose a portion of its share of the market to rival
firms. To regain lost customers typically requires heavy selling expenses, price reduction,
product improvements, and so forth.

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Do you know about types of floats and uses of floats? What is a float? Float could be defined as the amount of funds represented by checks that have been issued but not yet collected.It could be defined as the time between the deposit of checks in bank and its payment. Due to the time difference, many firms are able to “play the float,” that is, to write checks against money not presently in the firm’s bank account.
There are different kinds of floats that the firm has to encounter. These include:
Collection Float-Time taken to realise the money after the company has received the cheque from the debtors.
Mail Float-Time that elapses from the mailing of the cheque until its receipt.
Processing Float-Processing time after the cheque is received and before it is deposited with the bank.
Availability Float- Time taken from the deposit of the cheque to the funds being available in the bank. The last two items together make up deposit float and all the three items make up the collection float.
Float measurement -Float is usually measured in rupee-days, which are calculated by multiplying the time
lag in days by the rupee amount being delayed. Float can be measured either on each item that is processed or on an average daily basis.
Cost of Collection Float
The cost is determined by the following formula:
money in float * no. of days * daily interest rate * frequency of payment

Value of Payment Information
Matching payments to accounts in a timely and accurate manner. The biggest utilisation
is to update the systems so that actual positions of funds in the accounts are available.
Value of Relationship with Payee
Delays in posting may send wrong information to customers. Could also cause delays in shipments as you may be withholding shipments for the payments.

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A firm might invest excess cash in many types of interest-bearing assets. To choose among the alternatives, we must establish criteria based on our reasons for investing excess cash in the first place. We are investing either temporary transaction balances or precautionary balance or both. When we need the cash, we want to be able to obtain it-all of it-quickly. Given these objectives, we can rule out equity share and other investments with returns that are not contractual and with prices that often vary widely.Debt securities, with a contractual obligation to pay, are our best candidates. In selecting among debt securities, there are three principal characteristics we should examine: default risk, maturity and marketability.
Default risk refers to the possibility that interest or principal might not be paid on time and in the amount promised. If the financial markets suddenly perceive a significant risk of default on a particular secular security. The price of the security is likely to fall substantially, even though default may not actually have occurred. Investors in general are averse to risk, and the possibility of default is sufficient to depress the price. Given our purposes in investing excess cash, we want to steer clear of securities that stand any significant chance of defaulting. In an uncertain world, there is no guarantee that is absolutely certain. With its capacity to create money. However, there are securities available with default risk that is sufficiently low to be almost negligible. In selecting securities, we must keep in mind that risk and return are related, and that low-risk securities provide the lowest returns. We must give up some return in order to purchase safety.
Maturity refers to the time period over which interest and principal payments are to be made. A 20 years bond might promise interest semiannually and principal at the end of the twentieth year.A 6-month bank certificate of deposit would promise interest and principal at the end of the sixth month. When interest rates vary, the prices of fixed-income securities vary.A rise in market rates produces a fall in price, and vice versa. Because of this relationship, debt securities are subject to a second type of risk. Interest rate risk, in addition to default risk. A government bond, though free of default risk, is not immune to interest rate risk. The longer the maturity of a security, the more sensitive its price is to interest rate changes and the greater its exposure is to interest rate risk. For this reason, short maturities are generally best for investing excess cash.

Marketability refers to the ease with which an asset can be converted to cash. With reference to financial assets, the terms marketability and liquidity often are used synonymously. Marketability has two principal dimensions-price and time-that are interrelated. If an asset can be sold quickly in large amounts at a price that can be determined in advance within narrow limits, the asset is said to be highly marketable or highly liquid. Perhaps the most liquid of all financial assets are Treasury Bills. On the other hand, if the price that can be realised depends significantly on the time available to sell the asset, the asset is said to be illiquid. The more independent the price is of time, the more liquid the asset. Besides price and time, a third attribute of marketability is low transaction costs.

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Within a group of companies it is often considered desirable for cash to be managed by
a central department which will:

1. Gather in all surplus funds from the various companies and redistribute them in accordance with the investment opportunities which best serve the group objectives;
2. Dictate the investment opportunitiesof the subsidiary companies to ensure that funds are retained where they are needed within the group;
3. Arrange the investment outside the business of funds which are temporarily surplus to group needs;
4. Negotiate centrally any bank overdraft facilities, and the raising of new long-term capital.
   With regard to internal investment it sometimes appears that priority is given to projects from those companies which are already profitable (since they are able to show better incremental returns than those which are currently less successful); and it is argued that the loss-making companies may well have the greater need for operations.
   In relation to overdraft facilities, the argument for Group central negotiation is that only one banker (or a lead banker) will be involved who will be well informed on the whole of the group’s activities, and that all the resources of the group will be available as security. This does, however, put the whole group at risk if credit facilities are reduced. If the various companies have a good local relationship with the banks they have used
   individually in the past, it can happen that the total of locally negotiated overdrafts is greater than could have been obtained centrally. While the withdrawal of one facility still leaves the other companies untouched. The payment of creditor accounts centrally is easier to arrange, though it may involve delays in payment if involves first to be approved by local offices. Whether centralised purchasing is beneficial will depend on whether the advantages of standardised specifications and the negotiation of build discounts are offset by a loss of specialised purchasing skills for a diverse range of products and by delays in the procurement of urgently needed supplies. The majority of the foregoing comments will apply equally to a single company having divisional profit centre in scattered locations.

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Credit policy will directly influence sales, investment levels, bad-debt losses, and collection costs.
Sales: Sales vary directly with the extent to which credit terms are liberalised. The demand for a firm’s product is greatly influenced by the ease with which the products can be purchased on credit. Sales will be at their lowest level if they are strictly for cash. Those who want to buy on credit will patronise other manufacturers who extend credit. Sales will start increasing as credit terms are liberalised. Sales will be at their maximum level when the firm does not screen buyers for credit worthiness. Rather, credit is extended to all who want to buy the firm’s products.
Investment Levels: Sales on credit result in accounts receivable. As discussed above, sales are directly related to the liberality of credit terms. As credit terms are liberalised, sales increase and to service this increased level of sales properly, the firm needs to increase its investments in cash and inventories. Finally, if sales increase sufficiently, the firm may have to increase its productive capacity.As credit terms are made more
liberal, the firm’s investment in cash accounts receivable, inventories, and perhaps physical equipment increases in a complimentary fashion.
Bad-Debt Losses: Without credit sales the firm will not incur any bad-debt losses. With a very conservative credit policy, bed-debt losses will be nonexistent or minimal. As credit terms are liberalised, the firm begins to give credit to marginally less-creditworthy clients. The liberalisation of credit terms result in increases in bad-debt losses.
Collection Costs: Collection costs are the clerical and administrative costs associated with granting credit and managing accounts receivable. When credit is not granted, collection costs are minimal. As credit terms liberalised, the firm’s volume of accounts receivable increases. The clerical and administrative costs of invoicing, collecting, and book keeping also increase as credit terms are liberalised. A second type of collection cost is the one related to efforts to collect on delinquent accounts. As credit terms are liberalised, delinquent accounts increase and the costs of efforts to collect on these accounts also increases.

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An individual or firm is requesting credit. What sources of information are available to judge the credit worthiness of the applicant? Sources that can be utilised are financing statements, bank references, and credit bureaus.
Financial Statements: A vital source of information is the applicant’s financial statements. An applicant who is in a financially sound position would have no hesitation in making available his or her financial statements. Interim reports, if available, are more desirable than annual reports.Audited and CPA certified reports are preferred to unaudited reports. The financial statements are useful for calculating various liquidity, leverage, efficiency, and profitability ratios that may be used in evaluating credit risk. If the firm is using a credit scoring model  or if the applicant is requesting a large amount of credit, financial statements are essential.                                                                                                                                                                                 Bank references – these may not give a lot of information but they tend to use a series of standardised replies, and experience of these will indicate the relative credit grading of the customer in question;
Credit Bureaus: Credit bureaus specialise in consolidating the experiences of other firms with the applicant. Credit bureaus compile a history of the applicant’s credit payment performance as reported by the credit-granted firms. Financial information on
a credit applicant may be obtained by credit bureau member firms who agree to provide credit bureaus with information on their clients.
In addition to these information sources, a firm may try to compile its own information. It may have its sales personnel prepare a report on the credit applicant.Alternatively, if the credit request is large enough, it may send a credit department employee to visit personally with the credit applicant and garner as much financial information as possible. Reports published in trade journals or the financial press dealing either with the
customer company or with the type of business in which it is engaged.

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Profit here would normally be interpreted as accounting profit, This objective arises from the fact that the shareholders are the owners of the business and, as such, both the exercisers of ultimate control and the
beneficiaries of profits. It is therefore argued that the shareholders will cause managers to pursue policies that would be expected to result in the maximum possible profit. This analysis is acceptable up to a point, but maximising profit could easily be sub-optimal to the shareholders. It may be possible to increase profit by expanding the
business’s scale of operations. If the increase merely results from the raising of additional external finance, it might mean that profit per share could actually decrease,
leaving the shareholders worse off.
Pharmaceutical products manufacturers typically spend vast amounts of money on developing and testing new products. It is in the nature of the industry that the time taken to bring a new drug to the market can easily be ten years. A particular business that stopped spending money on research and development would enhance current
profit because costs would be cut but revenues arising from continuing to sell drugs developed in past years would continue for the time being. Thus current profits would be buoyant but the business would face a bleak future since there would be no new drugs to replace the old ones.
It is probably open to most businesses to increase their profits without additional investment if they are prepared to take additional risks. For example, cost cutting on the control of the quality of the business’s output could lead to increased profits, at least in the short term. In the longer term, placing substandard products on the market could lead to the loss of future sales and profits.
Clearly, increasing profitability through greater efficiency is a desirable goal from the shareholders’ point of view. However, maximisation of profit is far too broad a definition of what is likely to be beneficial to shareholders.

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One of the most utilised money market instruments, ICDs are the hallmark of lending
and borrowing between companies and high-networth individuals. Usually backed by a
security, (typical security being shares) ICD is normally for three months, but higher
and shorter periods are also prevalent depending upon the needs. Normally the maximum
time frame of an ICD is six months. But ICDs are rollable (turned over from one period
to another) and can extent to any period with the mutual consent of the lender and the
borrower.
It is one of the instruments which many cash rich corporates like to park their funds in
as the security is good and the interest rate is much higher than what they would get
from banks for the same time period. Risks of default are also much higher and it is
normally not possible to offload the securities in the market, as the market may not be
able to absorb the same.
Importance of personal contacts cannot be denied as this market operates from word
of mouth and no advertising is done because it could harm the reputation of the corporate
borrowing through ICDs. One of the top criteria for getting ICDs is the credibility of
the company in the market, the lessor the credibility the lower the chances of getting
the ICDs and the higher the interest rate the company may have to pay.

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Bank guarantee is one of the facilities that the commercial banks extend on behalf of
their clients in favour o£ third parties who will be the beneficiaries of the guarantees. In
fact when a bank guarantee is given no credit is extended and banks do not part with
any funds. There will be only a guarantee to the beneficiary to make payment in the
event of the customer on whose behalf the guarantee is given, defaulting in his
commitment. So, if the customer fails to pay as per the terms of the guarantee, the
banker giving the guarantee has to pay and claim reimbursement from his client. The
banker’s liability arises only if his customer fails to pay the beneficiary of the guarantee.
That is why bank guarantee limits are known as non-borrowings limits or non-fund
limits.
Important features – The following points are to be considered regarding bank guarantee:

1. Guarantees should be for a definite period and as far as possible should not run
   for more than one year.
   2The guarantees should be in respect of a definite object or enforceable on happening
   of a definite event.
2. Guarantee should be in respect of transactions which arise out of trade and
   commerce, or any other genuine business.
3. Guarantees should be specific as to amount.
4. Guarantees should be covered by a counter guarantee by a customer giving the
   bank absolute right of payment under guarantee on the happening of contingency
   guaran-teed against.
5. Reliable credit reports should be obtained on the customers for whom the guarantee
   is given. Such reports should be kept uptodate.
6. The guarantees should as far as possible relate to the normal business of the
   customers. The banks will insist the customer to deposit the margin, depending on
   case to case, before the issue of bank guarantees. The banks will charge
   commission on bank guarantees issued or extended.

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Factoring is becoming popular all over the world in view of the variety of services
rendered by factors to business organisations. Its importance has tended to increase in
recent years owing to growing industrialisation and consequential growth in the volume
of industrial production and sales. A factor, by dint of the function of buying debts
without recourse, not only provides financial support to his client firm and meets a
portion of its working capital, but also relieves the latter of the botheration of collecting
the receivables from the customers and suffering losses due to bad debts. The firm
may also avoid the necessity of operating a credit department for analysis and collection.
In addition to rendering financial assistance, a factor assists his client in credit planning
and control. On the basis of the information and assessment of creditworthiness of
potential customers, a factor is able to advise his client whether to extend credit to a
particular buyer or not, and if it is to be extended, the amount and period therefor.
A factor may also generate other useful information for his clients. The factor, on
account of a large volume of transactions handled by him, is in a position to computerise
the operations and hence is equipped to perform book-keeping services for more
efficiently and expeditiously than an average business concern.
It is important to note that firms that are small or have seasonal sales patterns may
realise substantial savings in credit and collections because the factor serving a large
number of accounts can realise economies of scale and also can achieve better
diversification with respect to default risk.
However, the most critical fall-out of factoring is institutionalisation and perpetuation of
credit and perhaps even delayed payments. Further, any tough stance taken by the
factor against a defaulting buyer may have its direct impact on such borrower cutting
short his orders on the particular seller. In a buyer’s market, few sellers can afford to
irritate customers.

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