Financial Management

Financial Management:

 

Meaning of Financial Management

Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the enterprise. It means applying general management principles to financial resources of the enterprise.

Scope/Elements

1. Investment decisions includes investment in fixed assets (called as capital budgeting). Investment in current assets are also a part of investment decisions called as working capital decisions.
2. Financial decisions - They relate to the raising of finance from various resources which will depend upon decision on type of source, period of financing, cost of financing and the returns thereby.
3. Dividend decision - The finance manager has to take decision with regards to the net profit distribution. Net profits are generally divided into two:
1. Dividend for shareholders- Dividend and the rate of it has to be decided.
2. Retained profits- Amount of retained profits has to be finalized which will depend upon expansion and diversification plans of the enterprise.

Objectives of Financial Management

The financial management is generally concerned with procurement, allocation and control of financial resources of a concern. The objectives can be-

1. To ensure regular and adequate supply of funds to the concern.
2. To ensure adequate returns to the shareholders which will depend upon the earning capacity, market price of the share, expectations of the shareholders.
3. To ensure optimum funds utilization. Once the funds are procured, they should be utilized in maximum possible way at least cost.
4. To ensure safety on investment, i.e, funds should be invested in safe ventures so that adequate rate of return can be achieved.
5. To plan a sound capital structure-There should be sound and fair composition of capital so that a balance is maintained between debt and equity capital.

Functions of Financial Management

1. Estimation of capital requirements: A finance manager has to make estimation with regards to capital requirements of the company. This will depend upon expected costs and profits and future programmes and policies of a concern. Estimations have to be made in an adequate manner which increases earning capacity of enterprise.
2. Determination of capital composition: Once the estimation have been made, the capital structure have to be decided. This involves short- term and long- term debt equity analysis. This will depend upon the proportion of equity capital a company is possessing and additional funds which have to be raised from outside parties.
3. Choice of sources of funds: For additional funds to be procured, a company has many choices like-
1. Issue of shares and debentures
2. Loans to be taken from banks and financial institutions
3. Public deposits to be drawn like in form of bonds.

Choice of factor will depend on relative merits and demerits of each source and period of financing.

4. Investment of funds: The finance manager has to decide to allocate funds into profitable ventures so that there is safety on investment and regular returns is possible.
5. Disposal of surplus: The net profits decision have to be made by the finance manager. This can be done in two ways:
1. Dividend declaration - It includes identifying the rate of dividends and other benefits like bonus.
2. Retained profits - The volume has to be decided which will depend upon expansional, innovational, diversification plans of the company.
6. Management of cash: Finance manager has to make decisions with regards to cash management. Cash is required for many purposes like payment of wages and salaries, payment of electricity and water bills, payment to creditors, meeting current liabilities, maintainance of enough stock, purchase of raw materials, etc.
7. Financial controls: The finance manager has not only to plan, procure and utilize the funds but he also has to exercise control over finances. This can be done through many techniques like ratio analysis, financial forecasting, cost and profit control, etc.

Financial activities of a firm is one of the most important and complex activities of a firm. Therefore in order to take care of these activities a financial manager performs all the requisite financial activities.

A financial manger is a person who takes care of all the important financial functions of an organization. The person in charge should maintain a far sightedness in order to ensure that the funds are utilized in the most efficient manner. His actions directly affect the Profitability, growth and goodwill of the firm.

Following are the main functions of a Financial Manager:

1.     Raising of Funds

In order to meet the obligation of the business it is important to have enough cash and liquidity. A firm can raise funds by the way of equity and debt. It is the responsibility of a financial manager to decide the ratio between debt and equity. It is important to maintain a good balance between equity and debt.

2.     Allocation of Funds

Once the funds are raised through different channels the next important function is to allocate the funds. The funds should be allocated in such a manner that they are optimally used. In order to allocate funds in the best possible manner the following point must be considered

§  The size of the firm and its growth capability

§  Status of assets whether they are long term or short tem

§  Mode by which the funds are raised.

These financial decisions directly and indirectly influence other managerial activities. Hence formation of a good asset mix and proper allocation of funds is one of the most important activity

3.     Profit Planning

Profit earning is one of the prime functions of any business organization. Profit earning is important for survival and sustenance of any organization. Profit planning refers to proper usage of the profit generated by the firm. Profit arises due to many factors such as pricing, industry competition, state of the economy, mechanism of demand and supply, cost and output. A healthy mix of variable and fixed factors of production can lead to an increase in the profitability of the firm. Fixed costs are incurred by the use of fixed factors of production such as land and machinery. In order to maintain a tandem it is important to continuously value the depreciation cost of fixed cost of production. An opportunity cost must be calculated in order to replace those factors of production which has gone thrown wear and tear. If this is not noted then these fixed cost can cause huge fluctuations in profit.

4.     Understanding Capital Markets

Shares of a company are traded on stock exchange and there is a continuous sale and purchase of securities. Hence a clear understanding of capital market is an important function of a financial manager. When securities are traded on stock market there involves a huge amount of risk involved. Therefore a financial manger understands and calculates the risk involved in this trading of shares and debentures. Its on the discretion of a financial manager as to how distribute the profits. Many investors do not like the firm to distribute the profits amongst share holders as dividend instead invest in the business itself to enhance growth. The practices of a financial manager directly impact the operation in capital market.

LC:

Letter Of Credit (L/C)

Letter of Credit (L/C) is a payment guarantee to the seller by the buyer’s bank. It is in fact, a Irrevocable Credit Contract whereby the buyer’s bank is committed (on behalf of the buyer) to place an agreed amount of money at the seller’s disposal clai8med by the negotiating on a particular date under some agreed conditions. If the conditions of the credit do not require for presentation of specified documents, it is called Clean Credit. On the contrary, if the presentation of specified documents is obligatory, the credit is called a Documentary Credit.

L/C Transmitting:

L/C is send to advising bank in three copies. The advising bank authenticates the original copy of L/C and delivers it to the exporter through Telex, Courier or SWIFT (Society for Worldwide Inter-bank Financial Telecommunication). The duplicate copy is kept with the advising bank.

Operational Procedure of L/C in Export & Import Business :

 

             

Exporter. Or                                                                                                     supplier.    Beneficiary.
Importer.    L/C opener.    Or applicant.

            Proforma invoice.

             

     Contract.          

                                

   Indentor’s  indent.           

Shipment the goods.

Issuing Bank This bank will deal with L/C for the buyer against supplier &through the L/C advising Bank.

Negotiating Bank. This bank negotiates with issuing bank in favor of exporter for the bill and pays the amount to the exporter.

Reimbursement Bank This bank deals with payment in favor of issuing bank
Advising Bank. This bank will deal with the exporter&inform the supplier that a L/C came from the buyer.

 

Types of letter of Credit

Letter of Credits may be either:

·Revocable

·Irrevocable.

Also There are special types of Letter of Credit (L/C)

·Transferrable L/C

·Red clause L/C

·Green clause L/C

·Back-to-back L/C

·Revolving L/C

Revocable credit

 A revocable credit is a credit that can be amended or cancelled by the issuing bank at any time without prior notice to the seller.

In case of seller (beneficiary), revocable credit involves risk, as the credit may be amended or cancelled while the goods are in transit and before the documents are presented, or although presented before payments has been made. The seller would then face the problem of obtaining payment on the other hand revocable credit gives the buyer maximum flexibility, as it can be amended or cancelled without prior notice to the seller up to the moment of payment buy the issuing bank at which the issuing bank has made the credit available. In the modern banking the use of revocable credit is not widespread.

Irrevocable credit

An irrevocable credit constitutes a definite undertaking of the issuing bank (since it can not be amended or cancelled without the agreement of all parties thereto), provided that the stipulated documents are presented and the terms and conditions are satisfied by the seller. This sort of credit is always preferred to revocable letter of credit.

Sometimes, Letter of Credits are marked as either ‘with recourse to drawer’ or ‘without recourse to drawer’s.

Revolving Credit

Which provides for restoring the credit to the original amount after it has been utilized.

Transferrable credit

If the word 'Transferable' incorporated in an L/C, then the L/C is transferable. The first beneficiary can transfer transferable L/C to second  beneficiary. But second beneficiary can not transfer it further to another beneficiary.

Back-To-Back L/C

The Back-To-Back L/C is a new credit opened on the bases of an original credit favor of other beneficiary under this concept the seller of the first credit offers it as security to the advising bank for the assurance of the second credit. The beneficiary of the Back-to-back credit may be located inside or outside the original beneficiary's country.

4.7) Accounting Procedure in case of L/C Opening

When the officer thinks fit the application to open a L/C, giving the following entries- creates the following charges-

 Showing accounting treatment at the time of L/C opening

Particulars	Debit/ Credit	Charges in Taka
Customer’s A/C	Debit
L/C Margin A/C	Credit	Commonly 10-30%
Commission A/C on L/C	Credit	0.5%
VAT	Credit	15% on commission
SWIFT Charge	Credit	3500/=
Foreign Courier Charge (FCC)	Credit	1000/=
Stamp	Credit	150/=
Securities and Printing	Credit	200/=

4.8) Parties to a letter of Credit

The parties are:

Ø         The Issuing Bank / Opening Bank

Ø         The Confirming Bank, if any, and

Ø         The Beneficiary / Seller / Exporter

Other parties that facilitate the Documentary Credit are

·The Applicant/ Buyer/ Importer

·The Advising Bank / Notifing Bank

·The Nominated Paying/ Accepting Bank,

·Negotiating Bank

·Re-imbursing Bank/ Paying And

·The Transferring Bank, if any

A. Applicant

The person or body (customer Of the bank) who requests the bank (opening bank) to issue letter of credit. The importer or buyer is the applicant of a letter of credit. Applicant must be the client kof the issuing bank.

B. Opening Bank / Issuing Bank

The bank that opens/issues letter of credit on behalf of the applicant/importer.

C. Advising Bank/ Notifying Bank

The bank through which the L/C IS advised to the beneficiary (exporter).

D. Exporter/ Seller/ Beneficiary

Beneficiary of the L/C is the party in whose favour the letter of credit is issued. Usually they are the seller or exporter.

E. Confirming Bank

The bank, which under instruction in the letter of credit, adds their irrevocable undertaking to that of the issuing bank. It is done at the request of the issuing bank having arrangement with them. The confirmation constitutes a definite undertaking on the part of confirming bank in addition to that of issuing bank.

F. Negotiating Bank

The bank that negotiates document and pays the amount to the beneficiary when presented complying credit terms. If the negotiation of the documents is not restricted to a particular bank in the L/C, normally negotiating bank is the banker of the beneficiary.

G. Reimbursing / Paying Bank

The bank nominated in the credit by the issuing bank to make payment against stipulated documents, complying with the credit terms. Normally issuing bank maintains account with the reimbursing bank.

 4.9) Necessity Of L/C For Importing Goods

An importer can purchase the goods directly up to the limit UD$ 5,000 from the exporter without opening a L/C through Bank Draft. For releasing the goods from the custom authority by the importer, bank will certify.

4.10) SOME IMPORTANT DOCUMENTS OF L/C

Forwarding:

 Forwarding is the letter given by the advising bank to the issuing bank. Several copies are sent to the issuing bank. All copies including original should be kept in the bank.

Bill of Exchange:

According to the section 05, Negotiable Instruments (NI) Act-1881, A “bill of exchange” is an instrument in writing containing an unconditional order signed by the maker, directing a certain person to pay [on demand or at fixed or determinable future time] a certain sum of money only to or to the order of a certain person or to the bearer of the instrument. It may be either at sight or certain day sight. At sight means making payment whenever documents will reach in the issuing bank.

Invoice:

 Invoice is the price list alongwith quantities. Several copies of invoice are given. Two copies should be given to the client and the other copies should be kept in the bank. If there is only one copy, then its photocopy should be kept in the bank and the original copy should be given to the client. If any original invoice contains the custom’s seal, then it cannot be given to the client.

Packing List:

Packing list is the letter describing the number of packets and there size. If there are several copies, then two copies should be given to the client and the remaining should be kept in the bank.  But if there is only one copy, then the photocopy should be kept in the bank and the original copy should be given to the client.

Bill of Lading:

Bill of Lading is the bill given by shipping company to the client. Only one copy of Bill of Lading should be given to the client and the remaining copy should be kept in the bank.

Certificate of Origin:

Certificate of origin is a document describing the producing country of the goods. One copy of the certificate of origin should be given to the client and the remaining copy should be kept in the bank. But if there is only one copy, then the photocopy should be kept in the bank and the original should be given to the client.

Shipment Advice:

The copy mentioning the name of the insurance company should be given to the client and the remaining copies should be kept in the bank. But if only one copy is given, then the photocopy should be kept in the bank and the original copy should be given to the bank.

Inco-Terms:

Inco-Terms simply mean International Commercial Terms. These are also known as Contract Terms or Trade Terms or Delivery Terms or Sales Terms Or Purchase Terms. These are used in the field of international trade or foreign trade.

Nostro Account:

The foreign currency account maintained by the authorised dealers in foreign exchange with the foreign banks/ correspondents are called Nostro Accounts. All foreign exchange transactions are routed through nostro accounts. Nostro Account means 'our account with you'.

Vostro Account:

Current Accounts of foreign banks with their correspondents in the latter,s currency is called Vostro Accounts. Vostro account means 'your account with us'.

Loro Account:

Loro Accounts are current accounts which the banks maintain with banks abroad on behalf of their clients. Loro Accounts means 'their account with you.

Export LC:

Formalities for Export L/C

There are a number of formalities, which an exporter has to fulfill before and after shipment of goods. These formalities or procedures are enumerated as follows, -

·Obtaining Export Registration Certificate ERC:

No exporter is allowed to export any commodity permissible for export from Bangladesh unless he is registered with Chief Controller of Imports and Exports (CCI & E) and holds valid Export Registration Certificate (ERC). After applying to the CCI&E in the prescribed from along with the necessary papers, concerned offices of the Chief Controller of Imports and Exports issues ERC. Once registered, exporters are to make renewal of ERC every year.

·Securing the order:

After getting ERC, the exporter may proceed to secure the export order. He can do this by contracting the buyers directly through correspondence.

·Obtaining EXP:

After having the registration, the exporter applies to PBL with the trade license, ERC and the Certificate from the concerned Government Organization to get EXP. If the bank is satisfied, an EXP is issued to the exporter.

·Signing of the contract:

After communicating with buyer the exporter has to get contracted for exporting exportable items from Bangladesh detailing commodity, quantity, price, shipment, insurance and mark, inspection, arbitration etc.

·Receiving the Letter of Credit:

After getting contract for sale, exporter should ask the buyer for Letter of Credit clearly stating terms and conditions of export and payment.

After receiving L/C, the following points are to be looked for:

·The terms of the L/C are in conformity with those of the contract.

·The L/C is an irrevocable one, preferably confirmed by the advising bank.

·The L/C allows sufficient time for shipment and a reasonable time for registration.

·If the exporter wants the L/C to be transferable, divisible and advisable, he should ensure those stipulations are specially mentioned in the L/C.

·Procuring the materials:

After making the deal and on having the L/C opened in his favor, the next step for the exporter is to set about the task of procuring or manufacturing the contracted merchandise.

·Endorsement on EXP

Before the export forms are lodged by the exporters with the customs/postal authorities, they should get all the copies endorsed by PBL. Before shipment, exporter submits exp. form with commercial invoice. Then PBL officer checks it properly, if satisfied, certifies the exp. Without it exporter he cannot make shipment. The customer must declare all exports goods on the EXP issued by the authorized dealers

Disposal of Export Forms:

·Original: customs authority reports first copy of EXP to Bangladesh Bank after shipment of the goods.

·Duplicate: Negotiating bank reports the Duplicate to Bangladesh Bank in or after negotiation date but not later than 14 days from the date of shipment.

·Triplicate: On realization of export proceeds Triplicate is reported by the same bank to the same authority.

·Quadruplicate: Finally, the negotiating bank as their office copy retains Quadruplicate

·Shipment of goods:Exporter makes shipment according to the terms and condition of L/C.

·Presentation of export documents for negotiation:

After shipment, exporter submits the following documents to PBL for negotiation.

·Bill of Exchange or Draft;

·Bill of Lading

·Invoice

·Insurance Policy/Certificate

·Certificate of origin

·Inspection Certificate

·Consular Invoice

·Packing List

·Quality Control Certificate

·G.S.P. certificate

Cash against Document (CAD) Contract

In lieu of export LC export can also be made against execution of contract of sale and purchase between the buyer and seller. Usually a CAD contract is made in case of exporting Jute goods.

There are some Bangladesh Jute Mills Corporation (BJMC) enlisted intermediary firms. They make CAD contract with the importer.  Some intermediary firms the client of PBL.  After making contract, the intermediary firm (original exporter) purchases jute from a jute mill.

·Commercial invoice made by the the jute mill

·Bill of exchange drawn on exporter payable to jute mills bank(authorized that bank as “ pay to the order of PBL”)

·Mills specification

·EXP form  triplicate and quadruplicate on which seal and signature of authorized officer of the jute mill’s bank is given.

Along with these jute mill documents exporter presents his own documents, which were required by the CAD contract .

Exporter presents the documents for negotiation to PBL and  request to remit the amount at which he purchased jute from jute mill to the jute mill’s bank and credit the rest to his account in PBL.

Examination of Document :

Banks deal with documents only, not with commodity. As the negotiating bank is giving the value before repatriation of the export proceeds it is advisable to to scrutinize and examine each and every document with great care whether any discrepancy(s) is observed in the documents. The bankers are to ascertain that the documents are strictly as per the terms of L/C Before negotiation of the export bill. Bank officers assigned for examining the export documents may use a checklist for their convenience.

Negotiation of export documents:

Negotiation stands for payment of value to the exporter against the documents stipulated in the L\C. If documents are in order, PBL purchases (negotiates) the same on the basis of banker- customer relationship. This is known as Foreign Documentary Bill Purchase (FDBP).

If the bank is not satisfied with the documents submitted to PBL gives the exporter reasonable time to remove the discrepancies or sends the documents to L/C opening bank for collection. This is known as Foreign Documentary Bill for Collection (FDBC)

·Procedure for FDBP:

·After purchasing the documents, DBL gives the following entries, -

FDBP A/C --------------------------------------------------Dr.

( at OD sight rate)

Customer A/C  -----------------------------------------------------Cr.

(Before realization of proceeds)

Bank would realize only postage charges from the exporter.

·Subsequently, Bank will send the documents to the L/C opening Bank for payment with a forwarding letter detailing the enclosures. Upon realization of proceeds the Negotiating Bank would pass the following vouchers:

Head Office A/C-------------------------------------------Dr.

( at T.T Clean rate)

FDBP A/C------------------------------------------------------------Cr.

Income A/C Profit on Exchange Trading-----------------------Cr.

(Adjustment after realization of proceeds)

·A FDBP Register is maintained for recording all the particulars.

·Foreign documentary bills for collection (FDBC):
EBL forwards the documents for collection due to the following reasons,-

·If the documents have discrepancies.

·If the exporter is a new client.

·The banker is in doubt.

FDBC signifies that the exporter will receive payment only when the issuing bank gives payment. PBL make regular follow-up with the L/C opening Bank in case of any delay in getting payment.

The exporter submits duplicate EXP Form and Commercial Invoice. Subsequently, the value of the bill is calculated and the following accounting entries are given, -

Head Office A/C---------------------------------------------------Dr. @ T.T Clean

Client’s A/C--------------------------------------------------------------------------Cr. @ OD sight

Government Tax A/C---------------------------------------------------------------Cr. @ 0.10 % of Invoice value

Postage A/C-------------------------------------------------------------------------Cr.

Income A/C profit on Exchange-------------------------------------------------Cr.

After passing the above vouchers, an Inter Branch Exchange Trading Debit Advice is sent for debiting the NOSTRO account. An FDBC Register is maintained, where first entry is given when the documents are forwarded to the issuing bank for collection and the second one is done after realization of the proceeds.

In case of discrepancies of minor nature, Bank may negotiate the documents depending on their confidence on the customer against execution of the Letter of Indemnity.

Mode of payment of export bill under L/C:

As per UCP 500, 1993 revision there are four types of credit. These are as follows:

·Sight payment

·Deferred payment

·By acceptance

·Negotiation

·Sight Payment Credit:

In a Sight Payment Credit, the bank pays the stipulated sum immediately against the exporter’s presentation of the documents.

·Deferred payment Credit:

In  deferred payment, the bank agrees to pay on a specified future date or event, after presentation of the export documents. No Bill of Exchange is involved. In PBL, payment is given to the party at the rate of D.A 60-90-120-180 as the case may be. But the Head office is paid at T.T clean rate. The difference between the two rates us the exchange trading for the branch.

·Acceptance credit:

In acceptance credit, the exporter presents a bill of exchange payable to himself and drawn at the agreed tenor (that is, on a specified future date or event) on the bank that is to accept it. The bank signs its acceptance on the bill and returns it to the exporter. The exporter can then represent it for payment on maturity. Alternatively he can discount it in order to obtain immediate payment.

·Negotiation Credit:

In Negotiation credit, the exporter has to present a bill of exchange payable to himself in addition to other documents, that the bank negotiates.

Export Procedure

4.15) Back-to-back L/C:

A Back-to-Back mechanism involves two separate L/Cs. One is master Export L/C and another is Back-to-Back L/C. On the strength of Master Export L/C bank issues bank to Back L/C. Back-to-Back L/C is commonly known as Buying L/C. On the contrary, Master Export L/C is known as Selling L/C.

Features of back-to-back L/C:

·-Is an Import L/C to procure goods /raw materials for further processing.

·-Is opened based on Export L/C.

·-Is a kind of Export Finance?

·-Export L/C is at Sight but back to Back L/C is at Usance.

·-No margin is required to open Back to back L/C

Checklist to open back-to-back L/C.

·Application is registered with CCI&E and has bonded warehouse license.

·The master L/C has adequate validity period and has not defective clause.

·L/C value shall not exceed the admissible percentage of net FOB value of relative Master L/C.

·Usance period will be up to 180 days.

Scrutinization of master L/C:

·Defective Points or Clauses appears in the Master L/C:

·Issuing bank is not reputed

·Advising credit by the advising bank without authentication.

·Port of destination absent.

·Inspection clause.

Nomination of specific shipping/Air line or nomination of specified vess