Tag: Significances

  • Capital Formation: Significances, Process, Stages, and also Meaning

    Capital Formation: Significances, Process, Stages, and also Meaning

    What does Capital Formation Mean? Capital formation means increasing the stock of real capital in a country. The following points highlight the Capital Formation: Significances, Process, Stages, and also Meaning; Significances of Capital Formation, Process of Capital Formation, Stages of Capital Formation, and Meaning of Capital Formation! Capital-formation refers to all the produced means of further production, such as roads, railways, bridges, canals, dams, factories, seeds, fertilizers, etc. Read and share the given article in English. Understand the Indian Capital Market!

    Explain and Introduction to Capital Formation.

    In other words, capital formation involves making more capital goods such as machines, tools, factories, transport equipment, materials, electricity, etc., which are all used for the future production of goods. For making additions to the stock of Capital, saving and investment are essential.

    #Meaning of Capital Formation:

    Capital-formation or accumulation plays a predominant role in all types of economics whether they are of the American or the British type, or the Chinese type. Development is not possible without capital-formation.

    According to Professor Nurkse,

    “The meaning of (Capital Formation) is that society does not apply the whole of its current productive activity to the needs and desires of immediate consumption, but directs a part of it to the tools and making of capital goods: tools and instruments, machines and transport facilities, plant and equipment— all the various forms of real capital that can so greatly increase the efficacy of productive effort. The essence of the process, then, is the diversion of a part of society’s currently available resources to the purpose of increasing the stock of capital goods so as to make possible an expansion of consumable output in the future.”

    Saving and investment are essential for capital formation. According to Marshall, saving is the result of waiting or abstinence. When a person postpones his consumption to the future, he saves his wealth which he utilizes for further production, If all people save like this, the aggregate savings increase which is utilized for investment purposes in real capital assets like machines, tools, plants, roads, canals, fertilizers, seeds, etc.

    But savings are different from hoardings. For savings to be utilized for investment purposes, they must be mobilized in banks and financial institutions. And the businessmen, the entrepreneurs, and the farmers invest these community savings on capital goods by taking loans from these banks and financial institutions.

    #The Top significance of Capital the Formation:

    Capital formation or accumulation is regarded as the key factor in the economic development of an economy. The vicious circle of poverty, according to Prof. Nurkse, can easily be broken in underdeveloped countries through capital formation.

    It is the capital formation that accelerates the pace of development with fuller utilization of available resources. As a matter of fact, it leads to an increase in the size of national employment, income, and output thereby the acute problems of inflation and balance of payment.

    The following top Significance below is:

    Use of Human Capital Formation:

    Capital formation plays an extraordinary role in the qualitative development of human resources. Human capital formation depends on people’s education, training, health, social and economic security, freedom and welfare facilities for which sufficient capital in needed.

    Labor force needs up-to-date implements and instruments is sufficient quantity so that with the increase in population there will be an optimum increase in production and increased labor is easily absorbed.

    Improvement in Technology:

    In underdeveloped countries, capital formation creates overhead capital and necessary environment for economic development.

    This helps to instigate technical progress which makes impossible the use of more capital in the field of production and with an increase of capital in production, the abstract form of capital changes.

    It is seen that present changes in the capital structure lead to changes in the structure and size of technique and public is thereby more influenced.

    High Rate of Economic Growth:

    The higher rate of capital formation in a country means the higher rate of economic growth. Generally, the rate of capital formation or accumulation is very low in comparison to advanced countries.

    In the case of poor and underdeveloped countries, the rate of capital formation varies between one percent to five percent while in the latter’s case, it even exceeds 20 percent.

    Agricultural and Industrial Development:

    Modern agricultural and industrial development needs adequate funds for the adoption of the latest mechanized techniques, input, and setting of different heavy or light industries.

    Without sufficient capital at their disposal, leads to a lower rate of development thus, capital formation. In fact, the development of these both sectors is not possible without capital accumulation.

    Increase in National Income:

    Capital formation improves the conditions and methods for the production of a country. Hence, there is much increase in national income and per capita income. This leads to an increase in the quantity of production which leads to again rise in national income.

    The rate of growth and the quantity of national income necessarily depends on the rate of capital formation.

    So, the increase in national income is possible only by the proper adoption of different means of production and productive use of the same.

    Expansion of Economic Activities:

    As there is an increase in the rate of capital formation, productivity increases quickly and available capital is utilized in a more profitable and extensive way. In this way, complicated techniques and methods are utilized for the economy.

    This results in the expansion of economic activities. Capital formation increases investment which effects economic development in two ways.

    Firstly, it increases the per capita income and enhances the purchasing power which, in turn, creates a more effective demand.

    Secondly, investment leads to an increase in production. In this way, by capital formation, economic activities can be expanded in underdeveloped countries, which in fact, helps to get rid of poverty and attain economic development in the economy.

    Less Dependence on Foreign Capital:

    In underdeveloped countries, the process of Capital formation increases dependence on internal resources and domestic savings by which dependence on foreign capital is declined.

    Economic development leaves the burden of foreign capital, hence to give interest to foreign capital and bear expenses of foreign scientists, the country has to be burdened by improper taxation to the public.

    This gives a setback to internal savings. Thus, by the way of capital formation, a country can attain self-sufficiency and can get rid of foreign capital’s dependence.

    Increase in Economic Welfare:

    By the increase in the rate of capital formation, the public is getting more facilities. As a result, the common man is more benefited economically. Capital formation leads to an unexpected increase in their productivity and income and this improves their standard of living.

    This leads to improvement and enhancement in the chances of work. This helps to raise the welfare of the people in general. Therefore, capital formations the principal solution to the complex problems of poor countries.

    Capital Formation Significances Process Stages and also Meaning
    Capital Formation: Significances, Process, Stages, and also Meaning! Image credit from #Pixabay.

    #The Top 3 Process of Capital Formation:

    The process of capital formation involves three steps:

    1. Increase in the volume of real savings.
    2. Mobilization of savings through financial and credit institutions, and.
    3. Investment of savings.

    Thus the problem of capital formation becomes two-fold: one, how to save more; and two, how to utilize the current savings of the community for capital formation. We discuss the factors on which capital accumulation depends.

    1. How to Increasing Savings?

    The following savings below are:

    Power and Will to Save: 

    Savings depend upon two factors: the power to save and the will to save. The power to save the community depends upon the size of the average income, the size of the average family, and the standard of living of the people.

    Highly progressive income and property taxes reduce the incentive to save. But low rates of taxation with due concessions for savings in provident fund, life insurance, health insurance, etc. encourage savings.

    The perpetuation of Income Inequalities: 

    A perpetuation of income inequalities had been one of the major sources of capital formation in 18th century England and early 20th century Japan. In most communities, it is the higher income groups with a high marginal propensity to save that do the majority of savings.

    Increasing Profits: 

    Professor Lewis is of the view that the ratio of profits to national income should be increased by expanding the capitalist sector of the economy, by providing various incentives and protecting enterprises from foreign competition. The essential point is that the profits of business enterprises should increase because they know how to use them in productive investment.

    Government Measures: 

    Like private households and enterprises, the government also saves by adopting a number of fiscal and monetary measures. These measures may be in the form of a budgetary surplus through an increase in taxation (mostly indirect), reduction in government expenditure, expansion of the export sector, raising money by public loans, etc.

    2. How to Mobilization can Savings?

    The next step for capital formations the mobilization of savings through banks, investment trusts, deposit societies, insurance companies, and capital markets. “The Kernal of Keynes’s theory is that decisions to save and decisions to invest are made largely by different people and for different reasons.”

    To bring the savers and investors together there must be well-developed capital and money markets in the country. In order to mobilize savings, attention should be paid to the starting of investment trusts, life insurance, provident fund, banks, and cooperative societies.

    Such agencies will not only permit small amounts of savings to be handled and invested conveniently but will allow the owners of savings to retain liquidity individually but finance long-term investment collectively.

    3. How to Investment can Savings?

    The third step in the process of capital formations the investment of savings in creating real assets. The profit-making classes are an important source of capital formation in the agricultural and industrial sectors of a country.

    They have an ambition for power and save in the form of distributed and undistributed profits and thus invest in productive enterprises, besides, there must be a regular supply of entrepreneurs which are capable, honest and dependable. To these may be added, the existence of such infrastructure as well-developed means of transport, communications, power, water, educated and trained personnel, etc.

    #The Top 3 Stages of Capital Formation:

    The following stages below are:

    Creation of savings:

    Capital formation depends on savings. Saving is that part of national income which is not spent on consumption goods. Thus, if national income remains unchanged more saving implies less consump­tion. In other words, in order to save more and more people have to curtail their consumption voluntarily.

    If people reduce their consumption savings will increase. If consumption falls some resources used in the production of consumption goods will be released. The creation of money-savings in a country depends mainly on the people’s ability to save and partly on their willingness to save.

    Conversion of savings into investment:

    However, generation of sav­ings is not enough. Often people save money but this saving largely goes waste because saving is held in the form of idle balance (as in rural areas), or to purchase unproductive assets like gold and jewelry. This is why society’s actual savings falls below its potential savings. Thus, the genera­tion of savings is just a necessary and not a sufficient condition of capital formation.

    The actual production of capital goods:

    This stage involves the con­version of money-savings into the making of capital goods, or what is known as investment. The latter, in turn, hinges on the existing technical facilities available in the country, existing capital equipment, entrepreneurial skill, and venture, the rate of return on investment, the rate of interest, govern­ment policy, etc. 

    Thus the third stage of capital formations concerned with the actual production of capital goods. The process of capital formation is not complete unless business firms acquire capital goods so as to be able to expand their production capacity.

  • Features, Types, and Importance of Insurance

    Features, Types, and Importance of Insurance

    Insurance today has become an integral part of everyone’s life. It is a written contract of insurance that provides protection against future losses. Life insurance usually helps people to get life insurance. The insured gets a certain compensation from the insurer. Non-life insurance provides financial support to people or companies and helps them deal with losses. The basic human properties have to be contrary to the idea of taking the risk. Do you study to learn: If Yes? Then read the lot. Let’s Study: Features, Types, and Importance of Insurance. Read this in the Hindi language: बीमा की विशेषताएं, प्रकार, और महत्व…।

    The concept of Insurance Discussing the topic: Features, Types, and Significance or Importance of Insurance.

    Always insist on reducing risk and providing protection against potential failure. Risk includes fire, see danger, death, accidents, and theft. Any risk can insure on the premiums corresponding to premiums including in the risk. Thus the collective impact of risk is insurance which provides reasonable security and assurance that the assured will protect in the event of any type of disaster or failure. Before this study, once read this article: Meaning, Definition, Principles, and Functions of Insurance.

    Features of Insurance:

    With the above explanation, we can find these following characteristics, which are generally celebrating in the case of life, sea, fire, and general insurance.

    A large number of insured persons:

    To spread the damage easily and easily, a large number of individuals should be insured. A small number of individuals can also be co-operative insurance, but it is limit to a small area. The cost of insurance for each member can be high. So, it can be impossible. Therefore, to make the insurance cheaper, it is important to ensure a large number of individuals or property because the cost of the insurance company will be the cost and therefore, the lower premiums will be.

    Sharing risks:

    Insurance is an event that is a person to share a financial event that may occur when a specific incident occurs on a person or his family. This event may be the death of a breadwinner for the family in case of life insurance, marine insurance in the fire, fire in fire insurance and other events in general insurance, for example, theft in theft insurance, accident in motor insurance, And so on. The loss arising from these incidents, if the insured person is sharing by all insured persons in the form of premium.

    Price of Risk:

    The amount of the insured’s share, the risk is evaluated before considering the idea, consideration or the premium. There are several ways to evaluate risks. If the higher loss is expected, then a higher premium can be charged. Therefore, the probability of loss is calculated at the time of insurance.

    Cooperative Equipment:

    The most important feature of each insurance plan is the cooperation of a large number of individuals who in reality agree to share the financial loss arising from any particular risk of the insured. This group of individuals can be brought through voluntary or publicity or through the request of agents. An insurer will be unable to fill all the losses due to its loss. Therefore, by ensuring or underwriting a large number of persons, he is able to pay the amount of loss. Like all cooperative pieces of equipment, there is no obligation on anyone to buy an insurance policy.

    Payment on contingency:

    Payment is made on a certain casualty insured. If contingency happens then payment is made. Since the life insurance contract is the contract of certainty, because the termination, death or expiry of the term will definitely be, payment is definitely fixed. In other insurance contracts, contingency is fire or marine hazard etc., may or may not be. Therefore, if contingency happens, payment is made, otherwise, no amount is given to the policyholder. Similarly, in certain types of policies, payment is not guaranteed due to the uncertainty of any particular contingency within a particular period. For example, in term-insurance, payments are made only when the death of the assured is within the specified period, maybe one or two years. Similarly, pure endowment payments are done only in the existence of the insured at the end of the term.

    Payment of forty loss:

    Another feature of insurance is the cordial loss of payments. An amicable loss is that which is unpredictable and unpredictable and as a result of opportunity. In other words, the loss should be casual. The law of a large number is based on the assumption that the losses are casual and occur randomly. For example, a person can slip on the snowy path and break a leg. The loss will be lucky. The insurance policy does not deliberately cover issues.

    Amount of Payment:

    The amount of payment depends on the value of the loss due to special insured exposure, provided the insurance is up to that amount. In life insurance, the objective is not good to face financial loss. The insurer promises to pay a fixed amount upon the occurrence of an event. If event or accident occurs, the payment fails if the policy is valid and applies at the time of the incident, such as property insurance, the dependents will not need to prove the loss of loss and the amount of loss. It is infinite in life insurance What was the amount of loss at the time of contingency. But in the property and general insurance, the amount of loss, as well as the event of loss, is required to prove.

    Types of Insurance:

    The following types are given below:

    Life Insurance:

    Life insurance is different from other insurance, in that sense, the subject matter of insurance is the life of a human. The insurer will pay a certain amount of insurance at the time of death or at the end of a fixed term. At present, life insurance enjoys the maximum scope, because life is the most important asset of a person.

    “Life insurance is a contract under which the insurance company – in consideration of a premium paid in lump sum or periodical installments undertakes to pay a pre-fixed sum of money on the death of the insured or on his attaining a certain age, whichever is earlier.”

    Everyone needs insurance. This insurance provides protection to the family prematurely or provides adequate amounts in old age when reducing the capacity. Under Personal Insurance, the payment is made in the accident. Insurance is not only security but it is a type of investment because a certain amount can return the assured to the end of death or term.

    General Insurance:

    General insurance includes property insurance, liability insurance, and other forms of insurance. Fire and marine insurance are strictly called property insurance. Motor, theft, loyalty and machine insurance involve a certain extent of liability insurance. The strict form of liability insurance is fidelity insurance, from which the insurer compensates the insured for losses when he is subject to payment liability to the third party.

    Property Insurance:

    Under the property, the insured property of the person/person is insured against a certain specified risk. Risk can damage property in fire or marine hazard, property theft or accident. Property of any person and society is insured against the loss of insurance and marine hazards, the unexpected decline in the crop reduction, the unexpected death of the animals engaged in the trade, the destruction of the machines and property theft is insured and goods.

    Marine Insurance:

    The Marine insurance provides protection against the loss of sea threats. In threats are confronting with a rock, or ship, enemies, fire, and captured by the pirate etc. There is no reason for ship, goods and freight traffic and disappearances in these hazards. So, marine insurance ship (plow), goods and freight.

    “A contract of marine insurance is a contract under which the insurance company undertakes to indemnify the insured against losses which are incidental to the marine adventure.”

    Earlier only some minor risks were insured, but now the scope of marine insurance was divided into two parts; Ocean marine insurance and inland marine insurance. The former only ensures the sea threats, while later the insured perils are included which can produce by the insured’s well-known delivery of the cargo (gods) and can increase the cargo by the buyer (importer) Go down

    Fire Insurance:

    Fire insurance involves the risk of fire. In the absence of fire insurance, fire waste will not only increase the person but also the society. With the help of fire insurance, damages caused by fire are compensated and society is not much lost. The person is given prioritization of such loss and his property or business or industry will remain in the same condition in which it was before the loss. Fire insurance does not only protect the loss, but it also provides some resulting loss, under this insurance war risk, upheaval, riots etc. can also insure.

    “Fire insurance is a contract, under which the insurance company, in consideration of a premium payable by the insured, agrees to indemnify the assured for the loss or damage to the property insured against fire, during a specified period of time and up to an agreed amount.”

    Liability insurance:

    General insurance also includes liability insurance, from which the insured is liable to pay the loss of property or to compensate for the loss of personality; Injury or death is seen as insurance fidelity insurance, automobile insurance, and machine insurance etc.

    Social insurance:

    Social insurance is to provide security to the weaker sections of the society who are unable to pay the premium for adequate insurance. Pension schemes, disability benefits, unemployment benefits, sickness insurance, and industrial insurance are different forms of social insurance. Insurance can classify into four categories from the risk point.

    Personal Insurance:

    Personal insurance includes insurance of human life which can cause damage due to death, accident, and illness. Therefore, individual insurance is further classifying by life insurance, personal accident insurance, and health insurance.

    Guaranteed Insurance:

    Guarantee insurance includes losses caused by dishonesty, disappearance, and employee or other party’s loyalty. The party must be a party to the contract. Their failure damages the first party. For example, in export insurance, the insurer will compensate the importer on the failure to pay the amount of loan.

    Miscellaneous insurance:

    Property, goods, machines, furniture, automobiles, valuable articles etc. maybe insure against damage or destruction due to accident or disappearance due to theft. There are different forms of insurance for each type of property, which not only provides property insurance but also liability insurance and personal injury is also insurers.

    Other forms of insurance:

    In addition to property and liability insurance, there is other insurance which is including in general insurance. Examples of such insurance are export-credit insurance, state employee insurance so that the insurer guarantees to pay a certain amount on certain events.

    The Importance and significance of Insurance:

    The process of insurance has developing to protect the interests of people with uncertainty by providing certainty of payment on any contingency. Insurance not only serves the ends of special groups of individuals, or individuals, it also transmits and transforms our modern social order.

    Here the role and importance of insurance have been discussed with the point of view of insurance, insurance, and society.

    Importance of Insurance to Individuals:

    • Insurance provides safety and security.
    • Also provides peace of mind.
    • Protects the mortgaged property.
    • They eliminate dependence.
    • Life-insurance encourages saving, and.
    • Life insurance provides profitable investment.

    Importance of Insurance to Business:

    • Business efficiency is increasing with insurance.
    • Enhancement of Credit.
    • Business continuation, and.
    • The welfare of the Employee.

    Importance of Insurance to Society:

    • The wealth of society is protecting, and.
    • Economic Growth of the country.

    The significance of Insurance:

    We can highlight the significance of insurance, in terms of the following advantages offered by it:

    • Concentration on Business Issues: Insurance help businessmen to concentrate their attention on business issues, as their risks are undertaken by the insurance company. Insurance gives them peace of mind. Thus due to insurance, business efficiency increases.
    • Better Utilization of Capital: Businessmen, in the absence of insurance, will maintain funds for meeting future contingencies. Insurance does away with this need to maintain contingency funds by them. Thus businessmen can better utilize their funds for business purposes.
    • Promotion of Foreign Trade: There are many risks in foreign trade much more than involved in the home trade. Insurance of risks involved in foreign trade gives a boost to its volume, which is a healthy feature of economic development.
    • The feeling of Security to Dependents: Life insurance provides a feeling of economic security to the dependents of the insured, on whose life insurance is affected.
    • Social Welfare: Life insurance also provides for policies in respect of education of children, the marriage of children etc. Such special policies provide a sense of security for the poor who take these policies. Thus life insurance is a device for ensuring social welfare.
    • Speeding Up the Process of Economic Development: Insurance companies mobilize the savings of the community through the collection of premiums and invest these savings in productive channels. This process speeds up economic development. Huge funds at the disposal of LIC (Life Insurance Corporation) available for investment purposes support the above-mentioned point of advantage of insurance.
    • Generation of Employment Opportunities: Insurance companies provide a lot of employment in the economy. This is due to the ever growing business done by insurance companies. Read this in the Hindi language: बीमा की विशेषताएं, प्रकार, और महत्व…।

    Features Types and Importance of Insurance

  • Cost of Capital: Meaning, Classification, and Importance!

    Cost of Capital: Meaning, Classification, and Importance!

    Investment in capital projects needs funds. The Concept of the study Explains – Cost of Capital: Meaning, What is the Cost of Capital? Components of Cost of Capital, Significance of the Cost of Capital, Classification of Cost of Capital, and the Importance of Cost of Capital. These funds are provided by the investors like equity shareholders, preference shareholders, debenture holders, etc in expectation of a minimum return from the firm. The minimum return expected by the investors depends upon the risk perception of the investor as well as on the risk-return characteristics of the firm. Also learn, Cost of Capital: Meaning, Classification, and Importance!

    Understand and Learn, Cost of Capital: Meaning, Classification, and Importance! 

    This minimum return expected by the investors, which in turn, is the cost of procuring funds for the firm, is termed as the cost of capital of the firm. Thus, the cost of capital of a firm is the minimum rate of return that it must earn on its investments in order to satisfy the expectation of the various categories of investors who have invested in the firm.

    What is the Cost of Capital?

    Meaning By accounting coach: The cost of capital is the weighted-average, after-tax cost of a corporation’s long-term debt, preferred stock, and the stockholders’ equity associated with common stock. The cost of capital is a percentage and it is often used to compute the net present value of the cash flows in a proposed investment. It is also considered to be the minimum after-tax internal rate of return to be earned on new investments.

    By Wikipedia: In economics and accounting, the cost of capital is the cost of a company’s funds (both debt and equity), or, from an investor’s point of view “the required rate of return on a portfolio company’s existing securities”. It is used to evaluate new projects of a company. It is the minimum return that investors expect for providing capital to the company, thus setting a benchmark that a new project has to meet.

    A firm procures funds from various sources by issuing different securities to finance its projects. Each of these sources of finance entails the cost to the firm. Since the minimum rate of return expected by various investors – equity investor and debt investor – will be different depending upon their risk perception of the firm, the cost of each source of finance will be different. Thus the overall cost of capital of a firm will be the weighted average of the cost of different sources of finance, with the proportion of each source of finance as the weight. Unless the firm earns this minimum rate of return, the investors will be tempted to pull out of the company, let alone, to participate in any further capital issue.

    We have seen that the cost of capital of a firm is the minimum required rates of return of various investors – shareholders and debt investors- who supply funds to the firm. How does a firm determine the required rates of return of each investor? The required rates of return are market determined and are reflected in the market price of each security. An investor, before investing in a security, evaluates the risk-return profile of investment and assigns a risk premium to the security. This risk premium and the expected return of an investor is incorporated in the market price of the security. Thus the market price of a security is a function of the return expected by the investors.

    Basic three Components of Cost of Capital: 

    There are various sources of finance that are used by the firm for financing its investment activities. The major sources are equity capital and debt. Equity capital represents ownership capital. Equity shares are financial instruments to raise equity capital. A debt may be in the form of secured/unsecured loans, debentures, bonds, etc. The debt carries a fixed rate of interest and the payment of interest is mandatory irrespective of the profit earned or loss incurred by the firm.

    Since interest payable on debt is tax deductible, the usage of debt provides a tax shield to the company. Basic three components as follows:

    1. Cost of Equity Share Capital: Theoretically, the cost of equity share capital is the minimum return expected by the equity investors. The minimum return expected by the equity investors depends upon the risk perception of the investor as well as on the risk-return complexion of the firm.
    2. Cost of Preference Share Capital: The cost of preference share capital is the discount rate which equates the net proceeds from the issue of preference shares to the present value of the expected cash outflows in the form of dividend and principal repayment on redemption.
    3. Cost of Debentures or Bonds: The cost of debentures or bonds is defined as the discount rate which equates the net proceeds from the issue of debentures to the present value of the expected cash outflows in the form of interest and principal repayment.

    Basic Significance of Cost of Capital: 

    The basic objective of financial management is to maximize the wealth of the shareholders or the value of the firm. The value of a firm is inversely related to the cost of capital of the firm. So in order to maximize the value of a firm, the overall cost of capital of the firm should be minimized.

    The cost of capital is of utmost importance in capital structure planning and in capital budgeting decisions.

    • In capital structure planning a company strives to achieve the optimal capital structure in order to maximize the value of the firm. The optimal capital structure occurs at a point where the overall cost of capital is minimum.
    • Since the overall cost of capital is the minimum rate of return required by the investors, this rate is used as the discount rate or the cut-off rate for evaluating the capital budgeting proposals.

    The Classification of Cost of Capital:

    The cost of capital defines as the minimum rate of return a firm must earn on its investment in order to satisfy investors and to maintain its market value. It is the investors required the rate of return. Cost of capital also refers to the discount rate which is used while determining the present value of estimated future cash flows. The major classification of the cost of capital is:

    Historical Cost and future Cost:

    Historical Cost represents the cost which has already been incurred in financing a project. It is calculated on the basis of the past data. Future cost refers to the expected cost of funds to be raised for financing a project. Historical costs help in predicting future costs and provide an evaluation of the past performance when compared with standard costs. In financial decisions, future costs are more relevant than historical costs.

    Specific Costs and Composite Cost:

    Specific costs refer to the cost of a specific source of capital such as equity shares, Preference shares, debentures, retained earnings etc. Composite cost of capital refers to the combined cost of various sources of finance. In other words, it is a weighted average cost of capital. It is also termed as ‘overall costs of capital’. While evaluating a capital expenditure proposal, the composite cost of capital should be as an acceptance/ rejection criterion. When capital from more than one source is employed in the business, it is the composite cost which should be considered for decision-making and not the specific cost. But where capital from only one source is employed in the business, the specific cost of those sources of capital alone must be considered.

    Average Cost and Marginal Cost:

    The average cost of capital refers to the weighted average cost of capital calculated on the basis of the cost of each source of capital and weights are assigned to the ratio of their share to total capital funds. The marginal cost of capital may be defined as the ‘Cost of obtaining another dollar of new capital.’ When a firm raises additional capital from only one source (not different sources) than marginal cost is the specific or explicit cost. Marginal cost is considered more important in capital budgeting and financing decisions. Marginal cost tends to increase proportionately as the amount of debt increase.

    Explicit Cost and Implicit Cost:

    Explicit cost refers to the discount rate which equates the present value of cash outflows or value of the investment. Thus, the explicit cost of capital is the internal rate of return which a firm pays for procuring the finances. If a firm takes the interest-free loan, its explicit cost will be zero percent as no cash outflow in the form of interest is involved. On the other hand, the implicit cost represents the rate of return which can be earned by investing the funds in the alternative investments. In other words, the opportunity cost of the funds is the implicit cost.

    Implicit cost is the rate of return with the best investment opportunity for the firm and its shareholders that will be forgone if the project presently under consideration by the firm were accepted. Thus implicit cost arises only when funds are invested somewhere, otherwise not. For example, the implicit cost of retained earnings is the rate of return which the shareholder could have earn by investing these funds if the company would have distributed these earning to them as dividends. Therefore, the explicit cost will arise only when funds are raised whereas implicit cost arises when they are used.

    The Importance of Cost of Capital:

    The cost of capital is a very important concept in financial decision making. Cost of capital is the measurement of the sacrifice made by investors in order to invest with a view to getting a fair return in future on his investments as a reward for the postponement of his present needs. On the other hand from the point of view of the firm using the capital, cost of capital is the price paid to the investor for the use of capital provided by him. Thus, the cost of capital is the reward for the use of capital. The progressive management always likes to consider the importance cost of capital while taking financial decisions as it’s very relevant in the following spheres:

    Designing the capital structure: 

    The cost of capital is the significant factor in designing a balanced and optimal capital structure of a firm. While designing it, the management has to consider the objective of maximizing the value of the firm and minimizing the cost of capital. Comparing the various specific costs of different sources of capital, the financial manager can select the best and the most economical source of finance and can design a sound and balanced capital structure.

    Capital budgeting decisions: 

    The cost of capital sources as a very useful tool in the process of making capital budgeting decisions. Acceptance or rejection of any investment proposal depends upon the cost of capital. A proposal shall not be accepted till its rate of return is greater than the cost of capital. In various methods of discounted cash flows of capital budgeting, cost of capital measured the financial performance and determines the acceptability of all investment proposals by discounting the cash flows.

    Comparative study of sources of financing: 

    There are various sources of financing a project. Out of these, which source should be used at a particular point in time is to be decided by comparing the costs of different sources of financing. The source which bears the minimum cost of capital would be selected. Although the cost of capital is an important factor in such decisions, equally important are the considerations of retaining control and of avoiding risks.

    Evaluations of financial performance: 

    Cost of capital can be used to evaluate the financial performance of the capital projects. Such as evaluations can be done by comparing the actual profitability of the project undertaken with the actual cost of capital of funds raised to finance the project. If the actual profitability of the project is more than the actual cost of capital, the performance can be evaluated as satisfactory.

    Knowledge of firms expected income and inherent risks: 

    Investors can know the firms expected income and risk inherent therein by the cost of capital. If a firms cost of capital is high, it means the firms present rate of earnings is less, the risk is more and capital structure is imbalanced, in such situations, investors expect the higher rate of return.

    Financing and Dividend Decisions: 

    The concept of capital can be conveniently employed as a tool for making other important financial decisions. On the basis, decisions can be taken regarding dividend policy, capitalization of profits and selections of sources of working capital.

    In sum, the importance of cost of capital is that it is used to evaluate the new project of the company and allows the calculations to be easy so that it has a minimum return that investor expectations for providing investment to the company.

    Cost of Capital Meaning Classification and Importance - ilearnlot

  • Commercial Banks: Meaning, Functions, and Significances

    Commercial Banks: Meaning, Functions, and Significances

    Commercial Banks: Banks have developed around 200 years ago. The nature of banks has changed as time has changed. This article explains Banks and their topics – Meaning, Functions, and Significances. The term bank relates to financial transactions. It is a financial establishment that uses, money deposited by customers for investment, pays it out when required, makes loans at interest exchanges currency, etc. however to understand the concept in detail we need to see some of its definitions. Many economists have tried to give different meanings to the term bank.

    Learn, Explain Commercial Banks: Meaning, Functions, and Significances.

    Meaning of Commercial Banks:

    A commercial bank is a financial institution that performs the functions of accepting deposits from the general public and giving loans for investment to earn a profit. Banks, as their name suggests, ax profit-seeking institutions, i.e., they do banking business to earn a profit.

    They generally finance trade and commerce with short-term loans. They charge a high rate of interest from the borrowers but pay much less rate of Interest to their depositors with the result that the difference between the two rates of interest becomes the main source of profit of the banks. Most of the Indian joint stock Banks are Commercial Banks such as Punjab National Bank, Allahabad Bank, Canara Bank, Andhra Bank, Bank of Baroda, etc.

    Definitions of Commercial Banks:

    While defining the term banks it takes into account what type of task performs by the banks. Some of the famous definitions are given below:

    According to Prof. Sayers,

    “A bank is an institution whose debts are widely accepted in settlement of other people’s debts to each other.”

    In this definition, Sayers has emphasized the transactions from debts raised by a financial institution.

    According to the Indian Banking Company Act 1949,

    “A banking company means any company which transacts the business of banking. Banking means accepting for the purpose of lending or investment of deposits of money from the public, payable on demand or otherwise and withdrawable by cheque, draft or otherwise.”

    Nature of Commercial Banks:

    They are an organization that normally performs certain financial transactions. It performs the twin task of accepting deposits from members of the public and making advances to needy and worthy people from society. When banks accept deposits its liabilities increase and it becomes a debtor, but when it makes advances its assets increase and it becomes a creditor. Banking transactions are socially and legally approved. It is responsible for maintaining the deposits of its account holders.

    Functions of Commercial Banks:

    The main functions of commercial banks are accepting deposits from the public and advancing them loans. However, besides these functions, there are many other functions that these banks perform.

    Paul Samuelson has defined the functions of the Commercial bank in the following words: 

    “The Primary economic function of a commercial bank is to receive demand deposits and honor cheques drawn upon them. A second important function is to lend money to local merchants farmers and industrialists.”

    The major functions performed by the commercial banks are:

    Accepting Deposits:

    This is one of the primary functions of commercial banks. The banks accept different types of deposits, the deposits may broadly classify as demand deposits and time deposits. The former refers to the deposits which are repayable by the banks on demand by the depositors, while the time deposits are accepted by the banks for a fixed period before the expiry of which they don’t return the deposit.

    The demand deposits include the current account deposits and savings bank account deposits. These two types of deposits earn a very low rate of interest as they can withdraw at any time. In the case of savings deposits, the depositor did not allow withdrawing more than a fixed number of times or amount over some time.

    More things:

    The time or term deposits include the fixed deposit and recurring deposits. In the former, a sum deposits for a fixed period determined at the time of deposit and never allows to withdrawal before the expiry of the period of deposit. Any such foreclosures will invite a penalty apart from forfeiting the interest.

    Recurring deposits are the type of deposits in which a depositor agrees to deposit a fixed sum of amount every month for several months as determined in advance, and at the end of which the depositor will be repaid his deposit amount along with interest. Every bank will be interested in mobilizing as much deposit as possible as it would improve its liquidity with which the bank can meet its liabilities and expand its business.

    Advancing of Loans:

    They accept deposits and use them for the expansion of their business. The banks never keep the deposits mobilized idle. After keeping some cash reserve, they invest the funds and earn. They also lend loans and advances to the common men after satisfying themselves about the creditworthiness of the borrowers. They grant different types of loans like ordinary loans in which the banks lend money against collateral security.

    Cash credit is another type of loan in which the entire amount sanctioned credits into the borrower’s account and he permits to withdraw only a specified sum at a time. Overdraft is yet another facility under which the customer allows to withdraw an amount subject to the ceiling fixed, from his account and he pays interest on the amount of overdrawn.

    Discounting bills of exchange is another type of advance granted by the banks in which a genuine trade bill discount by the banks and the holder of the bill gives the amount and the banks arrange to collect the due from the drawer of the bill on the date of maturity.

    Investment of Funds:

    One of the main functions of commercial banks is to invest their funds so as learn interest and returns apart from productively utilizing their funds. In India as per the statutes, banks must invest a part of their total investments in government securities and other approved securities to impart liquidity.

    Banks apart from enabling them to earn out of their investments, nowadays have set up mutual funds through which they mobilize funds from the people who invest them in very attractive projects which is a help rendered to the investors who otherwise will not have the benefit of participating in the project. Banks administer these mutual funds through specialists and experts whose services are not available to the common men.

    Agency Functions of Commercial Banks:

    Banks function as the agent of their customers and help them in several ways. For these agency services, the banks charge a nominal amount. The agency services include the transfer of customer’s funds, collection of funds on behalf of the customers, transactions in the shares and securities for their customers, collection of dividends on shares and interest on debentures for their customers, payments of subscriptions, dues, bills, premia on behalf of the customers, acting as the Trustees and Executor of the customers, offering financial and other consultancy services, acting as correspondents of the customers, etc.

    Purchase and Sale of Foreign Exchange:

    The banks account for by far the largest proportion of all trading of both a commercial and speculative nature and operate within what knows as the interbank market. This is essentially a market composed solely of commercial and investments that buy and sell currencies from each other.

    Strict trading relationships exist between the member banks and lines of credit are established between these banks before they are permitted to trade. They are a fundamental part of the foreign exchange market as they not only trade on their behalf and for their customers but also provide the channel through which all other participants must trade.

    They are in essence the principal sellers within the Forex market. One important thing to remember is that commercial and investment banks do not only trade on behalf of their customers but also trade on their behalf through proprietary desks, whose sole purpose is to make a profit for the bank. It should always remember that commercial banks have exceptional knowledge of the marketplace and the ability to monitor the activities of other participants such as the central banks, investment funds, and hedge funds.

    Financing Domestic and International Trade:

    This is a major function of commercial banks. International trade depends to a large extent on the financial and other support given by the banks. Apart from encouraging bills transactions, the banks also issue the letter of credit facilitating the importers to conduct their trade smoothly.

    The banks also process all the documents through consultancy services and reduce the botheration of the traders. They also lend based on commercial bills, warehouse receipts, etc., which help the traders to expand their business.

    Creation of Credit:

    It is worth noting the credit created by the commercial banks. In the process of their lending operations, they create credit. The process involves the following mechanism; whenever the banks lend loans, they do not pay cash to the be borrowers; instead, they credit the accounts of the borrowers and allow them to withdraw from their accounts.

    This means every loan given will create a deposit for the banks. Since every deposit is equal to money, banks are said to be creating money in the form of credit. As a result, the volume of funds required by the trade. The government and the country are met by the banks without any necessity to use actual cash.

    Other Functions:

    Other functions of commercial banks include providing safety vault facilities for the customers, issuing traveler’s cheques acting as referees of their customers in times of need, compiling statistics and other valuable information, underwriting the issue of shares and debentures, honoring the bills drawn on them by their customers, providing consultancy services on financial and investment matters to customers, etc.

    In the process of performing all the above-mentioned services. The banks play a key role in economic development and nation-building. They help the country in achieving its socio-economic objectives. With the nationalization of banks, the priority sector and the needy people provide sufficient funds which helm them in establishing themselves. In this way, the banks provide a firm and durable foundation for the economic development of every country.

    Commercial Banks Meaning Functions and Significances - ilearnlot
    Commercial Banks: Meaning, Functions, and Significances!

    Types of Commercial Banks:

    The following chart depicts the main types of commercial banks in India.

    Scheduled Banks and Non-scheduled Banks:

    Banks classify into two broad categories—scheduled banks and non-scheduled banks.

    Scheduled banks are those banks which include in the Second Schedule of the Reserve Bank of India. A scheduled bank must have a paid-up capital and reserves of at least Rs 5 lakh. RBI provides special facilities including credit to scheduled banks. Some of the important scheduled banks are the State Bank of India and its subsidiary banks, nationalized banks, foreign banks, etc.

    Non-scheduled Banks:

    The banks which did not include in the Second Schedule of RBI are known as non-scheduled banks. A non-scheduled bank has a paid-up capital and reserves of less than Rs 5 lakh. Such banks are small banks and their field of operation also limited.

    A passing reference to some other types of commercial banks will be informative.

    Industrial Banks provide finance to industrial concerns by subscribing (buying) shares and debentures of companies and also giving long-term loans to acquire machinery, plants, etc. Foreign Exchange Banks are commercial banks that are branches of foreign banks and facilitate international financial transactions through buying and selling of foreign bills.

    Agricultural Banks finance agriculture and provide long-term loans for buying tractors and installing tube wells. Saving Banks mobilize small savings of the people in the savings account, e.g., Post office savings bank. Cooperative Banks organizing by the people for their collective benefits. They advance loans to their members at a fair rate of interest.

    The Significances of Commercial Banks:

    Banks play such an important role in the economic development of a country that a modern industrial economy cannot exist without them. They constitute a Nerve center of production, trade, and industry of a country.

    In the words of Wick-sell,

    “Bank is the heart and central point of the modern exchange economy.”

    The following points highlight the significance of commercial banks:

    1. They promote savings and accelerate the rate of capital formation.
    2. They are the source of finance and credit for trade and industry.
    3. It promotes balanced regional development by opening branches in backward areas.
    4. Bank credit enables entrepreneurs to innovate and invest which accelerates the process of economic development.
    5. They help in promoting large-scale production and growth of priority sectors such as agriculture, small-scale industry, retail trade, and export.
    6. They create credit in the sense that they can give more loans and advances than the cash position of the depositor’s permits.
    7. It helps commerce and industry to expand their field of operation.
    8. Thus, they make optimum utilization of resources possible.
  • What are the Features of Controlling Functions?

    What are the Features of Controlling Functions?

    Features of Controlling Functions; Controlling is the last function of the management process which is performed after planning, organizing, staffing and directing. On the other hand, management control means the process to be adopted in order to complete the function of controlling.

    Here are explain; What are the Features of Controlling Functions?

    Following are the characteristics of controlling functions of management

    • Controlling is an end function: A function which comes once the performances are made in-Conformities with plans.
    • It is a pervasive function: which means it is performed by managers at all levels and in all type of concerns.
    • Controlling is forward-looking: because effective control is not possible without past being controlled. Control always look to the future so that follow-up can make whenever to require.
    • Controlling is a dynamic process: since controlling requires taking reviewal methods, changes have to be made wherever possible.
    • It is related to planning: Planning and Controlling are two inseparable functions of management. Without planning, controlling is a meaningless exercise and without controlling, planning is useless. Planning presupposes controlling and controlling succeeds in planning.

    Controlling has got two basic Process of Controlling:

    • It facilitates coordination.
    • It helps with planning.

    Also, know about; What is Controlling?

    Controlling consists of verifying whether everything occurs in conformities with the plans adopted, instructions issued and principles established. Control ensures that there is effective and efficient utilization of organizational resources so as to achieve the planned goals. Controlling measures the deviation of actual performance from the standard performance discovers the causes of such deviations and helps in taking corrective actions.

    What are the Features of Controlling Functions
    What are the Features of Controlling Functions? #Pixabay.

    Lets reading Definitions about Controlling; According to Brech,

    “Controlling is a systematic exercise which is called as a process of checking actual performance against the standards or plans with a view to ensuring adequate progress and also recording such experience as is gained as a contribution to possible future needs.”

    According to Donnell,

    “Just as a navigator continually takes reading to ensure whether he is relative to a planned action, so should a business manager continually take reading to assure himself that his enterprise is on the right course.”

    According to Henry Fayol,

    “Control consists of verifying whether everything occurs in conformity with the plan adopted, the instructions issued, and the principles”.

    Important Features of Controlling:

    Features of controlling could describe in the following analytical manner:

    • The unique feature of controlling, and.
    • Other features of controlling.

    Now, explain each;

    Unique Feature of Controlling:

    The unique feature of control is that it is the “central-tendency point” in the performance of managerial functions i.e. a point where all other managerial functions come together and unite with one another. This is so because, while contemplating corrective action, sometimes it might be necessary to modify plans or effect changes in the organizational setting. At some other times, changes in the staffing procedures and practices might be thought fit by management for remedial reasons.

    While at some junctures, management might plan to effect changes in the directing techniques of leadership, supervision or motivation, to bring performance on the right track. That is to say, that the remedial action comprised in the controlling process might embrace one or more managerial functions. Hence, controlling is designated as the central tendency point, in management theory.

    Other Features of Controlling:

    Some important basic features of controlling could state as under;

    • Controlling makes for a bridge between the standards of performance and their realistic attainment.
    • Planning is the basis of controlling; in as much as, the standards of performance are laid down in plans.
    • Controlling is a pervasive management exercise. All managers, at different levels in the management hierarchy, perform this function, in relation to the work done by subordinates under their charge-ship.
    • As controlling is the last managerial function, it is true to assert that it gives a finishing or final touch to the managerial job, at a particular point of time.
    • Controlling is based on information feedback i.e. on the reports on actual performance done by operators. In specific terms, it could say that information is the guide to controlling; as without information feedback made available to management, analysis of the causes of deviations and undertaking remedial action are not possible.
    • Action is the soul of controlling. In fact, controlling would be a futile activity; if after analyzing deviations – suitable remedial action is not undertaking by management, to bring performance, in conformity with plan standards.
    • Controlling is a continuous managerial exercise. It has to undertake on a regular and continuous basis, throughout the currency of the organizational operational life.

    Significances of Controlling:

    The significances of the controlling function in an organization are as follows:

    • Accomplishing Organisational Goals: Controlling helps in comparing the actual performance with the predetermined standards, finding out deviation and taking corrective measures to ensure that the activities are performing according to plans. Thus, it helps in achieving organizational goals.
    • Judging Accuracy of Standards: An efficient control system helps in judging the accuracy of standards. It further helps in reviewing & revising the standards according to the changes in the organization and the environment.
    • Improving Employee Motivation: Employees know the standards against which their performance will be judged. Systematic evaluation of performance and consequent rewards in the form of increment, bonus, promotion, etc. motivate the employees to put in their best efforts.

    Boundaries of Controlling:

    The defects or boundaries of controlling are as following:

    • Difficulty in Setting Quantitative Standards: It becomes very difficult to compare the actual performance with the predetermined standards if these standards are not expressing in quantitative terms. This is especially so in areas of job satisfaction, human behavior and employee morale.
    • No Control on External Factors: An organization fails to have control of external factors like technological changes, competition, government policies, changes in the taste of consumers, etc.
    • Resistance from Employees: Often employees resist the control systems since they consider them as curbs on their freedom. For example, surveillance through CCTV (closed-circuit television).