Features of Performance Budgeting 

Performance Budgeting provides

• The purpose and objectives for which funds are required
• Costs of programs and related activities proposed to accomplish those objectives
• The output that will be produced under each activity.

Performance Budgeting implies that the budget must clearly indicate the actual achievement or output, expected by spending a particular amount on a particular activity. Hence, It is an output oriented budget that focuses more on achievement rather than means of achievements.

The costs and benefits of each activity are analysed for making decisions regarding allocation of funds.

It involves use of management tools such as – work measurement, bench marking and unit costing etc. to prepare a budget.

This system has been designed to plan for long term.

Process of Performance Budgeting

• Formulation of objectives
• Identifying various programmes and project which will accomplish these objectives
• Evaluation & selection of programmes & projects on the basis of cost benefit analysis
• Development of performance criteria for various programmes
• Preparing financial plans for each program and the final annual budget
• Assessing the performance of each programme an comparing the same with budgeted performance
• Correcting deviations

Advantages of Performance Budgeting

• It states clearly the purpose & objectives for which funds are needed.
• It improves performance of units in a continuous manner
• It brings transparency in the budget formulation process
• It helps in decision making regarding allocation of funds
• It acts as a tool for reviewing efficiency of programs
• It integrates the process of planning, programming & budgeting

Limitations of Performance Budgeting 

• It focuses on quantitative evaluation rather than qualitative evaluation.
• It is ineffective without a proper and systematic accounting and reporting system.
• It is difficult to quantify social benefits.
• It is difficult to accurate estimate benefits arising out of each activity.

Also Read:  Zero-Based Budgeting

The post Performance Budgeting – Features, Process, Advantages, Limitations appeared first on BBA|mantra.

The chart below attempts to show a basic investment strategy of an investor. Percentage of total income to be spent on various investment alternatives are:

Different Investment Alternatives

(1) Negotiable Instruments / Securities – 

These investment alternatives can be traded in the market. 

(i) Variable Income Securities

• Equity Shares: Shares which do not carry any preferential rights in repayment of capital and dividend payments are equity shares. The rate of dividend is not fixed and varies depending upon the profitability, financial position and business objectives of a company. The owners of equity shares are the owners of the company and have voting rights in the management of the company.

Classification on the basis of nature of shares:

• Growth Shares: These stocks have a higher growth rate than the industry growth rate on the basis of profitability. E.g. HCL
• Income Shares: These stocks have a relatively stable operations and limited growth opportunities. E.g. Banks, FMGC, Cadbury, nestle, Hindustan lever
• Defensive Shares: These shares are normally not affected by the movements in the market. E.g. Pharma Stocks
• Cyclical Shares: These stocks are affected by the business cycles. The upward and downward movements of business cycles affect the profitability of the company and also the share price of a company. E.g. Automobile stocks
• Speculative Shares: These shares have a lot of speculative trading. They attract the investors in bull and bear phases of the market.

(ii) Fixed Income Securities

• Preference Shares – Shares which carry preferential rights in respect of dividend payment and repayment of capital are preference shares. These shares carry a fixed rate of divided and preference over equity shareholders in dividend payment and payment of capital at the time of liquidation. They do not carry any voting rights.

• Debentures – These are capital market instruments used to raise medium and long term capital funds from the public. It comprises of Periodic interest payments over the life of the instrument and principle payment at time of its redemption. These are for investors who wish to sacrifice liquidity for high returns.

• Bonds – They are similar to debentures but are issued by public sector companies. Its value in the market depends upon the interest rate and maturity of the bond. The coupon rate is the nominal interest rate offered on the bond which cannot be changed till its maturity. E.g. Education benefit bond, retirement benefit bond.

• IVP`s and KVP`s – These are savings certificates issues by the post office with the name Indra Vikas Patra and Kisan Vikas Patra. IVPs have a face value of 500,1000, 5000 and KVPs have a face value of 1000, 5000, 10000. The capital is doubled in 5.5 years with 13.47% rate of return. They do not carry any tax benefits but are transferable just like bearer bonds.

• Government Securities – These are secured securities issues by the central and state government. The rate of interest on these securities is relatively low but they are highly liquid and safe.

• Money Market Securities – These securities have very short term maturity usually less than a year. E.g. Treasury bills, Commercial paper, Certificate of Deposit

(2) Non Negotiable Instruments / Securities – These investment alternatives cannot be traded in the market. 

• Deposits:  Deposits earn a fixed rate of return.

• Bank Deposits – Banks usually offer three traditional facilities, they are; current account facility (no interest is paid), savings account (4-5% interest is paid) and fixed account (7-8% interest is paid).
• Post Office Deposits – Fixed deposit and Income schemes at Post offices provide around 13% to 15% interest rate.
• NBFC Deposits – NBFC`s having bet owned funds over 25 lakh can accept deposits with maturity ranging from 3-5 years and provide interest rate higher than commercial banks.

• Tax Sheltered Savings Scheme – These are beneficial for tax-paying Investors. They offer tax relief to its participants according to the taxation laws. E.g. Public Provident Fund Scheme, National savings scheme, National Saving Certificate, Public Provident Fund Scheme, National Savings Scheme, National Savings Certificate

• Life Insurance – It is a contract for payment of a sum of money to the person assured or entitled on happening of an insured event or at maturity. It also provides tax benefits to the person buying the insurance scheme. E.g. Basic Life Insurance: Whole Life Assurance Plan, Endowment Assurance Plan, Term Assurance Plans, Plans for Children, Pension Plans

(3) Mutual Funds

A mutual fund is a professionally-managed investment scheme, usually run by an asset management company that brings together a group of people and invests their money in stocks, bonds and other securities.

An investor can buy mutual fund ‘units’ which represent his/her share in a particular scheme. These units can be purchased or redeemed as needed at the fund’s current net asset value (NAV). These NAVs keep fluctuating, according to the fund’s holdings. All the mutual funds are registered with SEBI.

• Open Ended Mutual Fund Schemes – These offer its units on continuous basis and accept funds from investors continuously. There are no restrictions on buying or selling funds. These schemes do not have a maturity period and are not listed on the stock exchange. These provide liquidity to investors since repurchase facility is available.

• Closed Ended Mutual Fund Schemes – These have a fixed maturity period and are kept open for a limited period. Once closed the units are listed on the stock exchange. The demand and supply factors influence the price of the units.

Types of Mutual Fund Schemes

• Growth Schemes – These funds invest money in equities and offer high returns.
• Income Schemes – These funds invest money in fixed securities and provide a regular return to its holders.
• Balanced Schemes – These funds provide a steady return as well as a reasonable growth. The money is generally invested in equity and debt instruments.
• Money Market Schemes – These funds invest money in money market instruments like TB, CP.
• Tax Savings Schemes – These offer tax rebate to its investors. Equity linked saving schemes and pension schemes provide exemption from capital gains on specific investment.
• Index Schemes – These funds invest on equities of the index. The returns are approx. equal to the return of the Index.

(4) Non-Financial Instruments or Real Assets

These Investment alternatives usually form the major part of the investor`s portfolio. They include:

• Gold and Silver – They provide best protection against inflationary tendencies in an economy.
• Real Estate – They provide high returns to investors but require high investment and long term commitment. This investment alternative includes investment on land, buildings, any personal and property.
• Antiques – They usually guarantee safety of investment. A price rise is generally due to increased interest of collectors or increased social importance.

The post Investment Alternatives – Negotiable and Non-negotiable Instruments appeared first on BBA|mantra.

According to Securities Contracts Regulation Act, 1956, “securities include shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate.”

Classification of Securities

Securities can be divided into Corporate Securities and Government Securities on the basis of source of issue.

According to Securities Contracts Regulation Act 1956, a Government Security refers to a “security created and issued, whether before or after the commencement of this Act, by the Central Government or State Government for the purpose of raising public loans and having one of the forms specified in clause (2) of section 2 of the Public Debt Act, 1944.” While a corporate security refers to a security which is created and issued by an incorporated company or a body corporate.

On the basis of return, securities can be divided into Fixed Income and Variable Income Securities.

Types of Securities

• Equity Shares – A company`s share capital is divided into a number of equal and indivisible units of fixed amount, each of which is called a share. Shares which do not carry any preferential rights in repayment of capital (payment of principal amount) and dividend payments (payment of interest) are equity shares. The rate of dividend is not fixed and varies depending upon the profitability, financial position and business objectives of a company. The owners of equity shares are the owners of the company and have voting rights in the management of the company.

• Preference Shares – Shares which carry preferential rights in respect of dividend payment and repayment of capital are preference shares. These shares carry a fixed rate of divided and preference over equity shareholders in dividend payment and payment of capital at the time of liquidation of the company. They generally do not carry any voting rights.

• Non-voting Shares – These shares are entitled to the same stream of benefits as equity shares but carry higher dividends as they do not have any voting rights. On non-payment of dividend for 2 years these are automatically converted into voting shares.

• Right shares – These shares are offered as additional shares after the original issue to the existing shareholders of the company. Existing shareholders can subscribe to these in proportion of their existing holdings. These are issued to finance fund requirements of the company in times of need. They are usually offered at a discount. These can be issued only after two years of the formation of the company or one year after the first share allotment, whichever is earlier.

• Sweat Equity Shares – These are equity shares that are issued by a company to its board of directors and/or employees at a discount or for consideration other than cash, for providing managerial or technical know how or  for providing/making available some intellectual property rights or value additions; to the company. They form a part of the existing equity share capital of the company. 

• Bonus Shares – Bonus shares are issued for free to existing shareholders of the company by converting the reserves/profits of the company into share capital. It involves capitalization of the reserves of the company. These are issued for providing capital gains to shareholders out of company profits, when the business is in a profitable position. 

• Bonds & Debentures – These are long term debt instruments consisting of a promise by the issuer to pay a stipulated stream of cash flows in the future to the person holding the security. E.g. Govt. Securities, Savings Bond, PSU bonds, debentures of Private companies. They are used to raise medium and long term capital funds from the public. Such a security comprises of periodic interest payments over the life of the instrument and principle payment at time of its redemption.

• Share Warrant – It is a document issued by a public company that provides the right to the bearer/holder of the document to buy a specified number of shares at a specified time. The bearer does not enjoy the same benefits as equity share holders. Share Warrants can be freely traded in the market but require a prior approval of the central government before it is issued.

The post What are Securities & Types of Securities appeared first on BBA|mantra.

Presentation/Project/Slides Transcript

Topic: Dupont Analysis

Dupont analysis also Dupont model is a financial ratio based on return on equity ratio that is used to analyze a company’s ability to increase its return on equity.

It breaks down the return on equity ratio to explain how companies can increase their return for investors.

The Dupont analysis looks at three main components of the ROE ratio.

• Profit Margin
• Total Asset Turnover
• Financial Leverage

A company can increase its return on equity by maintaining a high profit margin, increasing asset turnover, or leveraging assets more effectively.

The Dupont Model equates ROE to profit margin, asset turnover, and financial leverage.

DuPont Analysis

ROE = Profit Margin X Total Asset Turnover X Financial Leverage

Analysis

Dupont Analysis was developed to analyze the ROE and the effects that different business performance measures have on this ratio. The objective is to analyze the variable causing the current ROE. For instance, if investors are unsatisfied with a low ROE, the management can use this formula to pinpoint the problem area whether it is a lower profit margin, asset turnover, or poor financial leveraging.

Once the problem is determined, management can attempt to correct deviations.

Example

• We have two companies Bob Retailers and Joey Retailers
• Both of these companies operate in the same industry and have the same return on equity ratio of 45 percent.
• This model can be used to show the strengths and weaknesses of each company.
• Each company has the following ratios:

BOB 45% = .30 x .50 x .30

JOEY 45% = .15 x 6.0 x .50

Both companies have the same overall ROE, but the companies’ operations may be completely different from each other.

Bob Retailers is generating sales while maintaining a lower cost of goods as evidenced by its higher profit margin. But, the company is having a difficult time turning over large amounts of sales.

Joey Retailers business is selling products at a smaller margin, but it is turning over a lot of products. This is evident from its low profit margin and extremely high asset turnover.

This model helps investors to compare similar companies like these with similar ratios. Investors can then evaluate perceived risks with each company’s business model.

The post Dupont Analysis with Example appeared first on BBA|mantra.

Factoring Process

The factoring process can be summarized in the activities of all the parties (client, buyer, factor) in a factoring agreement. Various tasks performed by the parties in a factoring process are:

Buyer –

• Enters into an agreement, negotiates and decides terms and conditions of sale agreement
• Takes delivery with invoice bill and instructions to make payment to the factor on due date
• Makes a payment or asks for extension. In case of default the buyer may face legal actions.

Seller –

• Enters into a contract of sale of goods on credit as per purchase order
• Sells goods as per contract
• Send copies of invoice, delivery challan along with goods to the buyer with instructions for making payment to factor
• Provides warranty that the customer has received the merchandise without any counter claim or disputes
• Sells the receivable received from the buyer to a factor and receives 80% or more in advance
• Receives the balance after paying the service charges

Factor –

• Enters into an agreement with the seller for rendering factor services i.e. collection of receivables
• Advises client on credit worthiness of potential clients
• Pays up to 80% advance on receiving sales documents
• Renders statement of accounts at periodic intervals to client and buyer
• Receives payments from the buyer and pays balance after deducting commission

Types of Factoring Agreements

(1) Recourse and Non-recourse factoring 

These types of factoring depend upon the type of credit protection provided by the factor.

In recourse factoring, the factor does not assume credit risks associated with the receivables and hence factoring does not include protection against bad debt. In such a factoring agreement the factor purchases the receivables arising out of sale of goods and provides all collection and maintenance services, but in case of non-payment by the buyer the client (seller) has to refund to money back to the factor.

In non-recourse factoring, the loss arising out of irrecoverable receivables (non-payment) is borne by the factor, he can only charge high commissions as compensation but cannot claim a refund. Hence, the client is protected against bad-debts. The additional fee charged as a premium for risk bearing is called DEL CREDERE Commission.

(2) Advance Factoring 

In these types of factoring, the factor pays a pre-specified portion ranging from ¾ to 9/10 of the factored receivables in advance, the balance being paid upon collection or on the guaranteed payment due. A drawing limit is made available to the client but the client has to pay an interest on the money he withdraws between the date of withdrawal and date of collection of receivables.

(3) Bank Participation Factoring 

In such a factoring agreement, the bank (factor) provides an advance to a client for financing a part of the factor reserve. Factor reserve is equal to Factor debt less advance payment by factor.

(4) Maturity or Collection Factoring 

In maturity factoring, the factor does not make an advance payment to the client. The payment is made either on the date of collection or on a guaranteed payment date. The guaranteed payment period is fixed taking into considerations –

previous experience with the client

and period for slow collection

(5) Full Factoring 

It is the most comprehensive form of factoring, also known as old line factoring. A full factoring agreement involves a plethora of services provided by the factor to the client including –

• Collection of receivables
• Protection against bad-debts
• Sales ledger administration
• Short Term finance

(6) Disclosed and Undisclosed Factoring 

In disclosed factoring, the name of the factor is disclosed in the invoice by the supplier (client) of the goods asking the buyer to make a payment to the factor.  The supplier may or may not continue to bear the risk of non-payment.

In undisclosed Factoring, the name of the factor is not disclosed although he maintains the sales ledger of supplier (client). Realization of business transactions are done in the name of supplier while the factor has all the control.

(7) Domestic and Export/Cross border/international factoring 

These types of factoring depend upon the domicile of the parties involved in a factoring agreement.

In domestic factoring the parties involved – customer (buyer), client and factor domicile in the same country.

In Export/Cross border/international factoring the parties reside in different countries. The parties involved are –

• exporter (client)
• importer buyer
• import factor
• export factor

The post Factoring Process & Types of Factoring appeared first on BBA|mantra.

Factoring Importance can be summarized in the points below:

Immediate increase in cash flow – The client does not wait for the credit time period as he receives money immediately from the factor and bears a nominal fee for the waiting period.

Less Costly – It reduces the financial burden on the client. It enables the client to invest somewhere else, save cost of manpower, maintenance of accounts, collection of money etc.

Professional Collection – A Factoring company has an efficient system for collection of receivables. Therefore they are experts in collection of debt. Each invoice is followed with a payment and the buyer and client are notified periodically with relevant information and due dates which leads to better productivity,

Invoice Processing – It relieves the factor from the task of mailing, posting, deposit of cheque, preparing reports etc.

Source of Finance – It accelerates the turnover of receivables, results in higher sales and return on investment, allows the client to expand his business etc.

Utility and Significance of Factoring

Credit Risk – The factor company takes the risk of default i.e. risk related to non-payment. The credit limit is fixed and defined therefore it relieves the client from burden of collection amount.

Maintenance of Sales Ledger – Ledger account of all debtors is maintained by the factor. An open account method is adopted and the factor prepares periodic reports for the client.

Collection of receivables – It is the responsibility of factor. The factor has trained manpower and well equipped infrastructure for this purpose.  Timely follow up is done and appropriate strategies are formed by the factor that save time and efforts, man power wastage, chances of bad debts etc.

Financing of trade debt – The factor provides up to 80% of the cost of goods sold in advance which reduces the financial burden on the client. Sometimes the factor provides full credit protection against bad debts.

Providing Advisory and Consultancy Services – The factor also provides the following Advisory and Consultancy Services to client:

• Guide the client about market trends of his/her products
• Assessing credit worthiness of the customer
• Systematic analysis and credit recovery
• Issuing letter of credit
• Auditing and dealing with sales return

Credit Analysis of the customer – The factor scrutinizes all information regarding outstanding balance, credit time period due, information from credit rating agencies, trade references, banking reports etc. which helps in better credit control.

Also Read: Introduction to factoring, Factoring Process, Types of Factoring

The post Factoring Importance, Utility and Significance appeared first on BBA|mantra.

Factoring is an agreement in which receivables arising out of a sale of goods/services are sold by a firm (client) to the factor (financial intermediary) as a result of which the title of  goods/services represented by the receivables passes on to the factor.

It is an arrangement between a factor and his client which includes any two of the following services provided by the factor to the client –

• Finance
• Maintenance of account
• Collection of debts
• Protection against credit risk

Through factoring an organization (client) relieves itself from the procedures and expenses of collecting receivables arising out of a sale and receives immediate cash to finance its business operations.

A factoring agreement involves three parties:

The Factor, The Client (sells receivables to factor), Customer (pays to factor)

Functions of a Factor:

• Maintaining Accounts – Preparing and updating sales ledger and providing periodic reports with useful information
• Providing advisory services – Advices the client regarding credit worthiness of a buyer, potential customers, market trends etc.
• Providing Short-term Finance – Provide money in advance up to 80% of the receivables
• Providing Credit Protection – Protects the client against bad-debts/non-payment
• Providing Collection Facilities – Collect money on behalf of the client and remits the money back after deducting his charges

Mechanism of Factoring 

A Factoring contact for sale of receivables –

• It starts with a credit sale and agreement between the client and the buyer/customer.

• The client (seller)

• Sells goods on credit to buyer/customer
• Prepares invoice, delivery challan, factoring agreement and other documents
• Hands over the documents to factor (Financial institution/Banking Institution)
• Receives payment in advance up to 80% of cost of good by the factor

• The factor

• Makes an advance payment to factor on receiving all the documents (invoice, challan, agreement etc.)
• Prepares and sends periodical account statements to customer
• Receives payment from customer/buyer on due date
• Remits the balance (20%) from the money collected to the client/seller after deducting its commission, fees, service charges etc.

Advantages of Factoring:

To Client/Seller –

• The client gets immediate cash on sale which can be invested somewhere else.
• It protects the client against credit risk i.e. risk of non-payment by buyer.
• It allows the client to offer lucrative credit schemes to customers and increase his sales and profit.
• It reduces the financial burden of the client and relieves him maintaining accounts and collection of receivables
• It acts as an additional source of finance for the client and allows him to explore new markets.

To Customers/Buyers – 

• It allows customers to save bank charges and expenses.
• It allows customers to purchase expensive products through flexible credit schemes.
• The factoring procedure is simple and easy than applying for a bank loan, it saves time, money and effort.

Also Read: Factoring Process, Types of Factoring, Factoring Importance, Utility and significance

The post Factoring – Introduction, Functions, Advantages to client & buyer appeared first on BBA|mantra.

 Leasing process

(1) Lease Selection –

• The leasing process starts when the lessee enters into a leasing contract with the lessor.
• Lessee approaches the Manufacturers and Suppliers, gathers all details about the required asset (design, specifications, price, installation, warranty, servicing etc.) and then takes a decision on the required asset and the supplier
• The lessee then goes to the leasing company or broker (lessor) and a lease agreement is broadly negotiated and finalized between them.

(2) Order, Delivery and payment – 

In the next step of leasing process:

• The Lessor orders the required asset to the selected manufacturer of asset to be leased on behalf of the lessee.
• The manufacturer delivers the asset at the site of the lessee
• The lessee inspects the delivery and gives a notice of acceptance to the lessor if he is satisfied with the asset.

(3) Lease contract –

The most important part of the leasing process is the lease contract:

• Both the parties sign a lease agreement setting out the details of the terms of contract. It usually ranges from 3 to 5 years.
• It may be fully pay out lease or nominal rentals may be charged.

(4) Lease Period –

• Regular lease rental are paid by the lessee.
• Lessee ensures proper maintenance of asset.
• Lessee is entitled to warranties and after sale services from the lessor.
• At the end of the lease period the lessee may either renew the lease or terminate it or buy the asset.

(5) Lease Agreement –

The lease agreement consists of all the obligations of the lessor and lessee. It includes:

• The basic lease period during which lease is irrevocable
• The time and amount of periodic rental payments to be paid
• Details of options to renew the asset or purchase it or in absence of such an option the lessor takes the possession of the asset
• Details regarding the responsibility of payment of cost of maintenance and repairs, taxes, insurance and other expenses
• In a Net Lease Agreement – Lessee pays all the above costs
• In a Maintenance lease agreement – Lessor pays all the costs

Advantages of Leasing 

To the lessee 

• It is a simple agreement, free from cumbersome procedures therefore, it saves time and effort.
• It helps in financing of capital goods like land, building, machinery etc. with small initial investment.
• It acts as an additional source of finance and helps the lessee to expand his business operations
• It is a cheaper source of finance than other alternatives
• A lease agreement allows for flexibility in rental payments and negotiation of agreement terms at the convenience of the lessee
• The lessee receives tax benefits
• Risk of Obsolescence of asset is avoided as the lessee has the option the replace the asset with the latest one.

To the Lessor 

• The lessor is fully secure as in case of default by lessee, the lessor can take back the asset as the ownership lies with him
• The lessor can lease assets with high depreciation rate and enjoy tax benefits by way of depreciation
• It is a highly profitable business, the lessor usually pays less interest on borrowings than what he charges from the lessee as premium
• The ultimate return on initial investment is very high

Disadvantages of Leasing 

To the Lessee 

• He has the right of use only there is no ownership, he cannot make major changes or alterations to the asset
• It is a costly option
• The lease may be canceled due to poor financial position of the lessee
• The lessee losses the residual value of the asset
• The lessee losses out on tax benefits due to depreciation and investment benefits if any
• The lessee may be subjected to penalties, if he terminates the contract before the expiry of lease period

To the Lessor 

• The lessor has to bear high risk of obsolesce of asset
• The lessor may not be able to charge sufficient rental due to enormous competition in the leasing market
• The lessor does not get the advantage of increase in price of asset due to price level changes as he can charge only fixed rentals during the entire lease period
• The lessor does not get any subsidies related to the asset as a usual buyer (user) would get
• It is a long term investment as the total cost of the asset is covered during the lease period which usually ranges from 3 to 5 years

More on Leasing: Leasing Introduction, Types of Lease

The post Leasing Process, Advantages and Disadvantages to lessor & Lessee appeared first on BBA|mantra.

The financial system of a country is an important tool for economic development of the country, as it helps in creation of wealth by linking savings with investments. It facilitates the flow of funds form the households (savers) to business firms (investors) to aid in wealth creation and development of both the parties.

The financial system of a country is concerned with:

• Allocation and Mobilization of savings
• Provision of funds
• Facilitating the Financial Transactions
• Developing financial markets
• Provision of legal financial framework
• Provision of financial and advisory services

According to Robinson, the primary function of a financial system is “to provide a link between savings and investment for creation of wealth and to permit portfolio adjustment in the composition of existing wealth”

A Financial System consists of various financial Institutions, Financial Markets, Financial Transactions, rules and regulations, liabilities and claims etc.

Features of Financial System:

• It plays a vital role in economic development of a country
• It encourages both savings and investment
• It links savers and investors
• It helps in capital formation
• It helps in allocation of risk
• It facilitates expansion of financial markets
• It aids in Financial Deepening and Broadening

Structure of Indian Financial System/Components of Indian Financial System:

(1) Financial Institutions – Financial institutions are intermediaries of financial markets which facilitate financial transactions between individuals and financial customers.

It simply refers to an organization (set-up for profit or not for profit) that collects money from individuals and invests that money in financial assets such as stocks, bonds, bank deposits, loans etc.

There can be two types of financial institutions:

• Banking Institutions or Depository institutions – These are banks and credit unions that collect money from the public in return for interest on money deposits and use that money to advance loans to financial customers.

• Non- Banking Institutions or Non-Depository institutions – These are brokerage firms, insurance  and mutual funds companies that cannot collect money deposits but can sell financial products to financial customers.

Financial Institutions may be classified into three categories:

• Regulatory – It includes institutions like SEBI, RBI, IRDA etc. which regulate the financial markets and protect the interests of investors.

• Intermediaries – It includes commercial banks such as SBI, PNB etc. that provide short term loans and other financial services to individuals and corporate customers.

• Non – Intermediaries – It includes financial institutions like NABARD, IDBI etc. that provide long-term loans to corporate customers.

(2) Financial Markets – It refers to any marketplace where buyers and sellers participate in trading of assets such as shares, bonds, currencies and other financial instruments. A financial market may be further divided into capital market and money market. While the capital market deals in long term securities having maturity period of more than one year, the money market deals with short-term debt instruments having maturity period of less than one year.

(3) Financial Assets/Instruments – Financial assets include cash deposits, checks, loans, accounts receivable, letter of credit, bank notes and all other financial instruments that provide a claim against a person/financial institution to pay either a specific amount on a certain future date or to pay the principal amount along with interest.

(4) Financial Services – Financial Services are concerned with the design and delivery of financial instruments and advisory services to individuals and businesses within the area of banking and related institutions, personal financial planning, leasing, investment, assets, insurance etc.

It involves provision of a wide variety of fund/asset based and non-fund based/advisory services and includes all kinds of institutions which provide intermediate financial assistance and facilitate financial transactions between individuals and corporate customers.

Functions of Indian Financial System

• It bridges the gap between savings and investment through efficient mobilization and allocation of surplus funds
• It helps a business in capital formation
• It helps in minimising risk and allocating risk efficiently
• It helps a business to liquidate tied up funds
• It facilitates financial transactions through provision of various financial instruments
• It facilitate trading of financial assets/instruments by developing and regulating financial markets

Importance of Indian Financial System

• It accelerates the rate and volume of savings through provision of various financial instruments and efficient mobilization of savings
• It aids in increasing the national output of the country by providing funds to corporate customers to expand their respective business
• It protects the interests of investors and ensures smooth financial transactions through regulatory bodies such as RBI, SEBI etc.
• It helps economic development and raising the standard of living of people
• It helps to promote the development of weaker section of the society through rural development banks and co-operative societies
• It helps corporate customers to make better financial decisions by providing effective financial as well as advisory services
• It aids in Financial Deepening and Broadening:

Financial Deepening – It refers to the increase in financial assets as a percentage of GDP

Financial Broadening – It refers to increasing number of participants in the financial system.

Financial Intermediaries/Intermediaries in Indian Financial System

• Commercial Banks
• Cooperative Banks
• Regional Rural Banks
• Development Banks
• Non-banking Financial Companies
• Mutual Fund companies
• Insurance Companies

The post Indian Financial System Introduction appeared first on BBA|mantra.

• The extent to which the risks and rewards are transferred
• The number and nature of parties to the transaction
• The domicile of the equipment manufacturer

Types of Lease:

On the basis of extent to which the risks and rewards are transferred there may be two types of lease:

(i) Financial Lease or Capital Lease – 

A financial Lease involves payment of lease rentals over one obligatory, non-cancelable lease period sufficient in total to amortize the capital invested by the lessor and also leave some profit.  It involves the transfer of all risks and rewards associated with the ownership of the asset to the lessee, but the title of ownership may or may not be transferred after the completion of lease period. Financial Lease may be of two types:

Full pay out lease – A Full Payout Lease covers the total value/cost of the asset through Lease rentals and scrap value. The lease period usually covers the entire economic life of the asset. 

True lease – A true lease only involves only taxation benefits for the lessor as he bears all the risks and rewards associated with ownership of asset and the lessee only gets the right to use the asset.

Eg. Ships, air crafts, railway wagon, land, heavy machinery.

(ii) Operating Lease –

An Operating lease has the following features:

• It does not transfer all the risks and rewards associated with ownership of the asset
• The cost of asset is not fully amortized during the primary lease period
• It consists of a cancellation clause
• Responsibility of maintenance and repair, insurance lies with the lessor
• The asset is provided on lease for a short period only, usually less than the useful life of the asset
• It is a high risk lease
• The Lease can be renewed after the expiry of term period

Eg. computer operator, taxi, printers.

Difference Between Operating Lease and Financial Lease:

On the basis of number and nature of parties involved in a transaction there may be the following types of lease:

(i) Sale and Lease back –

Under this type of lease the owner of the asset sells the asset to the lessor and takes it back on lease under the lease agreement i.e. the lessee is the owner of the asset. This type of lease helps in transferring the ownership from true owner to the lessor. This exchange of title helps (previous owner) the lessee in liquidating the funds tied up in a particular asset.

Hence, the seller of the asset becomes the lessee and the buyer of the asset becomes the lessor. The seller (lessee) receives the cost of asset and the right to use the asset, while the buyer enjoys the ownership of asset and lease rentals for the agreed period.

It is generally used in cases where assets are not subjected to depreciation and in industries where free finance is provided to the leasing company. 

E.g. Bank Lockers

(ii) Direct Lease –

In a Direct Lease, the lessee and owner of asset are different entities. It can be of two types: 

Bipartite Lease – In a Bipartite Lease, two parties are involved in a lease transaction i.e. equipment supplier or lessor and lessee. It is structured as an operating lease with inbuilt facilities like –

Upgrade lease – It provides an option to upgrade the equipment in future

Swap lease – It provides an option to replace an equipment with a similar equipment in working condition.

Tripartite Lease – In a Tripartite Lease the equipment supplier, lessor, lessee are different entities i.e. three parties are involved in a lease transaction.

It is a sales aid lease under which the equipment supplier arranges for lease finance in by –

• Providing reference about the customer to the leasing company
• Negotiating the terms with the customer
• Writing lease on his own account and discounting the lease receivables with designated leasing company

On the basis of the domicile of the equipment manufacturer there are three types of lease:

(i) Domestic lease – A lease in which all the parties under the lease contract are of the same country i.e. the equipment supplier, the lessor and lessee are domiciled in the same country, it is a domestic lease.

(ii) International or Cross border lease – In a cross border lease, the lessor and lessee are domiciled in different countries

(iii) Import Lease – In an import lease, mainly the equipment supplier is from a foreign country, the lessor and lessee may be in the same country.

Other types of Lease:

Leverage lease

In such a lease agreement, the lessor buys an asset through borrowed funds. Since huge capital is involved in purchase of heavy machineries and equipment, therefore, borrowed funds are used to finance an asset.  Generally there are three parties involved – a lessee (user), a lessor (leasing company) and a financer (Banks and Financial institutions). The lessor (leasing company) provides 20%-40% of the purchase value of the asset through equity capital and the remaining amount is borrowed from commercial bank or financial institutions (financer). Hence it is financed partly by debt and partly by equity.

E.g. Airplanes

Also Read: Introduction to Leasing

The post Types of Lease – Leasing appeared first on BBA|mantra.