MODULE 1

FOUNDATIONS FOR FINANCE

Introduction to basic concepts of finance; money and its need, Meaning and need for financial
planning; life goals and financial goals of an individual; Format of a sample financial plan for a
young adult; Time Value of Money and Valuation of Securities
Finance
It is considered as life-blood of the industry. It is derived from the Latin word “finis”
which means “end” and French word “fin” indicating fines or settlements. Finance is largely
associated with funds, money, capital, investment etc. It is an art and science of managing money.
It describes the management, creation and study of banking, credit, investments, assets, liabilities
and financial institutions.
According to Paul G Hasings, “Finance is the management of the monetary affairs of a
company”
According to Simon Andrade, “Area of economic activity in which money is the basis
of the various embodiments such as stock market instruments, real estate, industries,
agriculture and so on.”
Money
The word money derives from the Latin word moneta with the meaning "coin". Money is
a liquid asset used to facilitate transactions of value. Money plays an important role in monetary
economies. It is simply a unit of measure that is generally accepted and recognized as a medium
of exchange in the economy. It includes metallic money (coins), paper money (currency notes),
near money (gold, assets, bonds, debentures, shares) etc
According to Robertson, “Money is anything that is widely accepted in payment for goods
or in discharge of other kinds of obligations.”.

According to G. Crowther, “Money is anything that is generally acceptable as a means

of exchange and at the same time acts as a measure and store of value.”

It performs important functions namely medium of exchange, standard measure of value,

transfer of value, store of value, standard of deferred payments, determination of solvency of
borrowers etc.
Need for money
Prof. J.M. Keynes has given three important reasons as to why the individuals need money.
They are termed as motives of demand for money. They are
1) Transactionary motive: - It relates to the need for cash balances to carry on the day-to-
day transactions of individuals and business firms. A certain amount of ready money,
therefore, is kept in hand to make current payments. Business firms need money all the

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 time in order to pay for raw materials and transport, to pay wages and salaries and to meet
all other current expenses.

2) Precautionary motive: - Individuals hold some cash to meet expenses on illness,

accidents, unemployment and other unforeseen contingencies. Businessmen keep cash in
reserve to tide over unfavorable conditions.

3) Speculative motive: - Individuals and businessmen having funds, after keeping enough
for transactions and precautionary purposes, like to make a speculative gains by investing
in assets such as shares and bonds. They tradeoff between money to be kept in the form
of cash and in form of assets. It is based on market interest rate. At higher market interest
rates, individuals hold less amount of money in the form of cash, rather keep more amount
in the form of assets.
In general, money is needed for the following reasons

1) It is needed to fulfill various needs and wants of individuals

2) It is needed by the producer for producing goods and services
3) It is needed by the consumers for consuming goods and services
4) It is needed by the retailers or traders for distributing goods and services.
5) It is needed by the governments to spend on various socio-economic sectors, or to remove
various problems of the economy
6) It is needed to extend credit to various sectors through which they increase their output.
7) It is needed to build the capital stock and to adopt capital-intensive technologies
8) It is needed for economic growth and also for socio- economic welfare.

Financial Planning
It is simply the process of managing your hard earned money in an effective manner
with an intention to secure the present as well as future life.
It is an important part of financial management. It is defined as a process of determining
the budget in accordance with the various financial goals. It is also defined as the process of
framing financial policies in relation to procurement, investment and administration of funds of an
enterprise.
Financial planning refers to the process of streamlining the income, expenses, assets and liabilities
of the household to take care of both current and future needs.

Objectives
 To ensure the availability of sufficient funds to achieve the goals
 To minimize the cost of raising funds
 To ensure profits to the enterprise
 To simplify the capital structure by minimizing the number of securities
 To ensure optimum utilization of financial resources of enterprises
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  To frame financial policies to help the managers to take decisions regarding money and
funds.

Need and Importance

Financial planning is very crucial aspect for individuals or business enterprises to achive
financial success or to achieve financial stability. Here are some key reasons to understand the
need and importance of financial planning. They are

1. Goal Achievement: A well-crafted financial plan acts as a roadmap to help you accomplish
your life goals and financial goals, whether it's buying a house, starting a business, or retiring
comfortably.
2. Balance between wants and resources: A well-developed financial plan helps to identify
the unlimited wants or heads of expenditure and further prioritise its fulfilment in accordance
with the limited financial resources.
3. Balance between liabilities and assets: A sound financial plan helps the organisations to
maintain financial discipline and stability. Mismatch between liabilities and assets of the
balance sheet will be adjusted and will be balanced with the help of financial planning.
4. Financial Security: By effectively managing your finances, you can protect yourself and
your family members from unexpected events such as financial setbacks, job loss, medical
emergencies, or market downturns.
5. Debt Management: Financial planning helps you tackle your debts strategically, develop a
plan to repay them efficiently, and avoid falling into a debt spiral.
6. Wealth Creation: Through proper financial planning, you can identify opportunities to save
and invest your money wisely, generating wealth over time.
7. Retirement Planning: A comprehensive financial plan includes retirement savings,
ensuring you can maintain your desired lifestyle post your retirement.
8. Helps in reducing risks and uncertainties: Financial planning helps an individual to
mitigate the foreseen and unforeseen risks and uncertainties with adequate insurance
packages.
9. Helps in profit maximisation and profit optimisation. It helps the business organisation
to devise a plan by which they can minimise the cost in order to maximise their profits.
Further when the level of competition is high, it helps in optimising the profit levels in order
to sustain the business in long-run.
10. Helps in attracting investors and creditors: A well-developed financial plans helps to
make effective business proposals which will helps in winning the confidence of
investors/creditors and accordingly the prospects of investing in project will increase.
11. Helps in customers or employee retention: Customers and employees are equally
important for any organisation. Through better financial planning, organisation spend to
provide effective services to produce quality products leading to customer satisfaction. In
the similar way, it helps in providing better monetary packages, training facilities to the
employees and to retain the highly skilled employees.
12. Helps in increasing the standard of living: Lastly, it helps the individuals to come out of
adversities such as poverty, unemployment. It helps them to move form bare subsistence
level of living to desirable standard of living at which their socio-economic conditions are
improved. They will have enough purchasing power to spend on the necessary goods.

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Steps in the process of financial planning
1) Determination of Financial Situation: The existing financial situation with regard to
income, savings, expenses, debts, current liabilities, assets etc will be identified. This helps
in understanding the financial situation based on which the financial goals can be set.
2) Determination and prioritizing of Financial Goals: It involves projection of funds to be
invested on various types of financial goals – short-term, medium term and long-term.
Goals can be determined and developed based on SMART criteria- Specific, Measurable,
Attainable, Relevant and Time-bound. Further the goals can be prioritized based on its
urgency and importance. Generally, Eisenhower matrix can be applied for classifying the
goals. Usually short-term goals are those which are important and urgent, whereas medium
term and long-term tend to be important but not urgent.
3) Identification of Alternative Courses of Action: It is crucial for making good decision
for fulfillment of various goals. Different avenues of money market and capital market will
be explored and identified. It can be across deposits, insurance plans, retirement plans,
mutual funds etc..
4) Evaluation of Alternatives: Each alternative has to be evaluated critically. It deals with
evaluation of consequences of alternatives based on market conditions, rate of returns,
lock-in period, amount to be invested etc. Higher the risk, higher will be the return and
therefore one has to select the best alternative action to be implemented. Investors prefer
alternatives which carries lower risk and higher return
5) Creation and Implementation of Financial Plan: Based upon evaluation, a well curated
financial plan will be created and accordingly will be implemented. It will be monitored
and tracked to understand the progress of the plans. It might be in terms of paying the
installments on time, deposits at regular intervals, paying premium etc.
6) Re-evaluation of Financial Plan: It involves feedback system, frequent assessments,
regular reviewing of the action plans. It allows flexibility and will help you to make priority
adjustments in fulfillment of financial goals along with existing financial resources.

Life goals and financial goals

Life goals refer to those goals which are determined based upon personal interests, beliefs,
habits, lifestyle and ambitions. It refers to those objectives which an individual wish to fulfill in
order to have contended and happy life.
According to Nair, “Life goals are those desired states (preferences) that people seek to
obtain, maintain or to avoid.”
The various types of life goals are
a) Relationship goals
b) Fitness Goals
c) Education Goals

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 d) Travel goals
e) Leisure goals
f) Hobbies related goals
g) Career oriented goals
Financial Goals refers to those goals which are determined based upon the level of income,
owned assets, life-stage, access to credit etc. It is generally associated with earning, saving,
spending and investing. It specifies the sum of money required in order to meet the needs and when
it is required. It refers to monetary goals with which an individual secures his life with adequate
amount of money for fulfilling his needs and wants.
Examples for financial goals
 Well-stocked emergency fund
 Rs. 1 lakh required after 6 months to buy a car
 Rs. 30 lakhs required after five years for the college admission
 Retirement plans
 Sufficient insurance cover
 Investment in Mutual funds.. etc

It can be further divided as short-term goals, medium term goals and long-term goals.
a) Short-Term Goals: Short-term goals are something you want to achieve in the future
over the next few months. They have a typical timeline of 1 year. These are required
for your more immediate expenses. These expenses are generally smaller in scope and
easier to project and predict.
b) Medium-Term Goals
Medium Term lies between short term and long term. These goals have a typical
timeline of more than 1 year and upto 5 years. Clearing outstanding dues on your
credit card or personal loan can be classified under medium- term goals.
c) Long-Term Goals
Long-term goals have timeline of more than 5 years or about a decade to be fulfilled.
They require more deliberation to be implemented. For instance, Retirement expenses,
buying a house, and funding a child’s higher education are typical long-term goals.

Format of a financial plan

Financial plan refers to the roadmap consisting of tentative arrangement of financial goals
and the expected amount required to fulfill those goals. A financial plan is a document that details
a person’s current financial circumstances, their short- and long-term monetary goals, and their
strategies to achieve those goals.

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 Amount Target
Goal Type Specific Action Plan Required
Goals (Lakhs) Date
Short- Education Rs 8 lakhs Financing fees partly from parents 2025
Term (MBA) and partly by taking loans
Medium Purchase of Rs.15 By 2026 , portion of income will be 2027
Term Car lakhs saved to make down payment for
purchase of car and the remaining
will be funded by bank loan in 2027

Medium Going for Rs. 1 lakh Investing in equity and mutual funds 2028
Term Vacation to earn sufficient returns to fund
vacation for parents.
Long Term Marriage Rs. 20 Making investments in equities, debt 2030
lakhs and mutual funds to get sufficient
returns to cover your expenses
Long Term Purchase of Rs. 60 Making investments in fixed deposits 2032
House lakhs for 10 years, bank loan will be taken.
Money from EPF account also will be
used.

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Time Value of Money
It refers to the phrase “Time has got a value”. It refers to the idea that value of money
is different at different points of time. The value of certain amount of money today is more
valuable than its value in future as it is uncertain. Further since money can be put into productive
uses, its value is different depending upon when it is received or paid. It is also perceived that
money available at the present time is worth more than the same amount in the future due
to its potential earning capacity. It has a greater benefit of receiving money now rather than at
later.
Need for Time Value of Money
1) To estimate the future value of fixed deposits and recurring deposits at definite interest rates
2) To select the feasible investment plan based upon the expected returns and lock-in-period.
3) To determine interest rates and monthly installments
4) To solve the problems related to savings, loans, investment etc
5) To prepare better financial plans involving short-term and long-term decisions
6) To determine the status of investment proposals/ projects based on application of marginal
efficiency of capital
7) To realize the importance of savings, to overcome inflationary conditions and to meet
unforeseen calamities
8) To determine the prices and factor rewards such as rent, wages, interest and profits
Concepts of Time value of money
1) Simple Interest: It is the interest amount paid on a sum of money borrowed over a set time
period taking into account only the principal amount.
2) Compound Interest: It is the total amount of interest paid ona sum of money borrowed
taking into account principal amount and the accumulated interest of the previous periods.
3) Compounding: - It is the process of finding the future value of money based on present
cash flows at a specified rate of return at the end of the specified period. It is also known
as Future Value Technique.
4) Discounting: - It is an act of estimating the present value of money based on series of cash
flows to be received in future. It is rate used to discount the cash flows back to their present
value. It is also known as Present value technique.
5) Cash flows: - It is either as single sum or the series of payments or receipts occurring over
a specified period of time.
a) Cash inflows: Cash receipts for the investment made on assets or projects
b) Cash outflows: Series of payments made towards acquisition of assets over a period
of time
6) Annuities: It refers to uniform or even receipts or payments occurring over fixed number
of years. Examples: Monthly rents, loan EMIs, insurance premiums etc
7) Perpetuities: It is a type of annuity where there is no end to the payments or which doesn’t
has fixed maturity period. It refers to those securities on which there are infinite returns
paid ie., till the existence of the company. Example: Equity shares

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Difference between Compounding and Discounting
Compounding and Discounting are the two techniques of Time Value of Money. The
differentiation between these two techniques is tabulated below with reference to certain points
of differences
Basis of Differences Compounding Discounting
Meaning It is the process of determining the It is the process of estimating
future value of money on the basis of the present worth of money
the present amount of investment and on the basis of future cash
compound interest flows and discount rate
Concept If we invest some money today, how How much amount we need
much money we receive at future date to invest today to get a
specific amount in future.
Alternative name It is also known as Future Value It is also known as Present
Technique Value Technique
Formula 𝐹𝑉 = 𝑃𝑉 ( 1 + 𝑟)𝑛 𝐹𝑉
𝑃𝑉 =
(1 + 𝑟)𝑛
Use It is used to find the value of fixed It is used to find the present
deposits and recurring deposits, value of properties, marginal
efficiency of capital

The below chart specifies the difference between the two techniques of time value of
money in a simple manner.

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NOTE ON SECURITIES
SHARES
It is a unit or part of the authorized capital denoting a fixed value- face or nominal value.
The total authorized capital is divided into number of units based on face-value and each unit is
termed as Share.
As per the Companies Act of 1956, “A Share is a share in the share capital of the company.”

Types of Shares

1) Equity Shares:
 They are ordinary shares representing owner’s capital in a company.
 These shares provide permanent capital to the company and cannot redeemed
during the lifetime of the company.
 When the company goes into liquidation, they will get their investment back only after
all the company’s obligations are paid.
 Equity shareholders are the real owners of the company and they have the voting
rights in the meetings of the company and have a control over the working of
company.
 Whenever the public limited company proposes to increase its subscribed capital by
the allotment of further shares and such shares should be offered to existing
shareholders. This is called pre-emptive rights.
 The liability of equity shareholders is limited to the face value of shares held by
them.

2) Preference Shares:
 Company shares which are given first preference or first priority in respect of dividend,
repayment or refund of share capital in the event of liquidation or winding up of the
company.
 They are stock with dividends that are paid before common stock dividends are paid
out.
 They do not hold voting rights unless it is related to their rights of redeeming the
payments.
 They have a right to claim dividend for those years also for which there were no profits.

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Types of Preference Shares
a) On the basis of dividend rights - Cumulative and Non- Cumulative:
 The holders of cumulative preference shares are entitled to receive a fixed percentage
of dividends before anything is given, to other classes of shareholders. If the company
has no profits in any year, it needs to declare dividend, then the arrears of dividend
would accumulate and become payable
 Non-cumulative preference shares are entitled to a fixed rate of dividend only for the
years when the company earns sufficient profits and dividend is declared. In case the
company has no profits in any year, then the arrears of dividend will not accumulate.
b) On the basis of Rights to Profits - Participating and Non-Participating
 The holders of these shares are entitled to participate in the surplus profits of the
company along with the equity share-holders with a special provision in the Articles
of Association.
 The holders of non-participating preference shares will get only a fixed rate of dividend
but are not entitled to participate in the surplus profits of the company.
c) On the basis of Convertibility - Convertible and Non-Convertible
Convertible preference shares are given the rights to convert into equity shares later
on after a certain period. On the other hand, non-convertible preference shares are not
given the right to convert into equity shares later on.
d) On the basis of redemption - Redeemable and Irredeemable
 Redeemable shares can be returned or paid back even during the existence of the
company as per the terms of issue either at a definite date after the expiry of fixed
period or at the option of the company. Only fully paid shares can be redeemed out
of the profits of the company or out of fresh issue of shares.
 Irredeemable shares are those which are not refundable until the company is liquidated.
It is perpetual in its nature.

DEBENTURES:
It is a long-term security yielding a fixed rate of interest issued by the company. They are
issued mainly on the credibility of the issuer and therefore without any collateral securities. It also
refers to loan certificates issued by a company to its investors, employees etc. It is an
acknowledgement of a debt provided by the company. It is mainly issued for setting up new
project, expansion or diversification of existing project or for mergers and amalgamations.

Features of Debentures
1) Provides long-term funds to a company
2) Debenture holders are the creditors of the company and not the owners
3) Fixed rate of interest is payable and is a legal obligation of the company
4) They do not have voting rights or preemptive rights

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Types of Debentures
1) Convertible Debentures: It can be fully convertible into Equity shares and guarantee the
voting rights.
2) Non-convertible debentures: It retain the debt character and cannot be converted into
equity shares.
3) Redeemable Debentures: It has a fixed period at which the payment of loan’s principal
amount and interest has to be undertaken. Under Section 121 of Company’s Act of 1956,
Redeemable Debentures can be reissued.
4) Irredeemable Debentures: There is no fixed date. It is at the option of the company to
pay back the loan amount, but the interest has to be regularly paid.
5) Fixed debentures: Type of debenture on which the rate of interest is pre-determined and
do not fluctuate till the returns are redeemed.
6) Floating debentures: Type of debenture on which the variable rate of interest is put forth.
Pre-determined rate of interest at the time of issue is compared to the market rate of interest,
whichever stands higher is adjusted and returns are redeemed.

There are other types of debentures namely registered and bearer debentures, Specific
coupon rate debentures and Zero coupon rate debentures etc.

BONDS

They are high-security debt instruments having fixed interest rate issued by government
entities and companies. They are backed up by collateral securities and are issued with different
term periods. It is considered as risk-free investment and are known as Gilt-edged securities due
to its backing up of collateral securities. Gilt-edged securities are favored by investors who seek
predictable returns, with little risk of default. The term “Gilt-edged” is of British origin, and were
referred to the debt securities issued by the Bank of England whose paper certificates had a gilt (or
gilded) edge.

Types of Bonds

There are various types of bonds. Based upon the maturity period, there are short-term
bonds, intermediate bonds and long-term bonds. The other types of bonds are briefly discussed
below
1) Coupon and Zero coupon bonds: Coupon bonds are those bonds on which certificates of
coupons are attached. These coupons are detachable certificates which carry fixed rate of
interest known to bond-holders. They are issued at the time of redemption.
Zero coupon bonds do not carry any coupon rate and the bond holders will not get
any interest. Further for compensating against zero interest, company issues them at
discount price which is less when compared to its face value. The benefit is the difference
between the issue price and face value. They are known as Deep Discount Bonds.

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2) Inflation-linked or inflation indexed bonds: These bonds offer returns which are indexed
to the existing inflation rate. As the inflation rate rises, the returns on these bonds also rise.
3) Deferred interest bonds: In this case, a low rate of interest is paid at the start of the term
period, whereas it increases near the term end.
4) Joint bonds: These bonds are guaranteed by pledge of securities by two or more
companies. They are issued when two or more companies are in need of investment and
decide to raise the funds together through bonds.
5) Masala Bonds: These bonds are issued by Indian companies in the foreign countries or to
the foreigners and the returns are paid in Indian rupees. These bonds carry term-period upto
5 years. In other words, Masala bonds are rupee-denominated bonds issued by Indian
entities to raise money from overseas markets.
6) Sovereign Gold Bonds: These bonds are issued by Reserve Bank of India on the behalf of
Government of India for a period of 8 years and the returns are denominated in grams of
gold. SGBs are government securities denominated in grams of gold. They are substitutes
for holding physical gold. Investors have to pay the issue price in cash and the bonds will
be redeemed in cash on maturity.

Differences between Debentures and Bonds in a nut shell

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