Tag: University of Mumbai BMS Notes

Cost Volume-Profit (CVP) relationship is an analysis which studies the relationships between the following factors and its impact on the amount of profits.

In simple words, CVP is a management accounting tool that expresses relationship among total sales, total cost and profit. Cost Volume-Profit relationship is one of the important techniques of cost and management accounting. It is a powerful tool which furnishes the complete picture of the profit structure and helps in planning of profits. It can also answer what if type of questions by telling the volume required to produce. This concept is relevant in all decision making areas, particularly in the short run.

Managerial accounting provides useful tools, such as cost-volume-profit relationships, to aid decision-making. Cost volume profit relationship helps you understand different ways to meet your company’s net income goals.

1. The Basics of Cost-Volume-Profit (CVP) Analysis

Cost-volume-profit (CVP) analysis is a key step in many decisions. CVP analysis involves specifying a model of the relations among the prices of products, the volume or level of activity, unit variable costs, total fixed costs, and the sales mix. This model is used to predict the impact on profits of changes in those parameters.

(a) Contribution Margin

Contribution margin is the amount remaining from sales revenue after variable expenses have been deducted. It contributes towards covering fixed costs and then towards profit.

(b) Unit Contribution Margin

The unit contribution margin can be used to predict changes in total contribution margin as a result of changes in the unit sales of a product. To do this, the unit contribution margin is simply multiplied by the change in unit sales. Assuming no change in fixed costs, the change in total contribution margin falls directly to the bottom line as a change in profits.

(c) Contribution Margin Ratio

The contribution margin (CM) ratio is the ratio of the contribution margin to total sales. It shows how the contribution margin is affected by a given dollar change in total sales. The contribution margin ratio is often easier to work with than the unit contribution margin, particularly when a company has many products. This is because the contribution margin ratio is denominated in sales dollars, which is a convenient way to express activity in multi-product firms.

2. Some Applications of CVP Concepts

CVP analysis is typically used to estimate the impact on profits of changes in selling price, variable cost per unit, sales volume, and total fixed costs. CVP analysis can be used to estimate the effect on profit of a change in any one (or any combination) of these parameters. A variety of examples of applications of CVP are provided in the text.

3. CVP Relationships in Graphic Form

CVP graphs can be used to gain insight into the behavior of expenses and profits. The basic CVP graph is drawn with dollars on the vertical axis and unit sales on the horizontal axis. Total fixed expense is drawn first and then variable expense is added to the fixed expense to draw the total expense line. Finally, the total revenue line is drawn. The total profit (or loss) is the vertical difference between the total revenue and total expense lines. The break-even occurs at the point where the total revenue and total expenses lines cross.

4. Break-Even Analysis and Target Profit Analysis

Target profit analysis is concerned with estimating the level of sales required to attain a specified target profit. Break-even analysis is a special case of target profit analysis in which the target profit is zero.

(a) Basic CVP equations

Both the equation and contribution (formula) methods of break-even and target profit analysis are based on the contribution approach to the income statement. The format of this statement can be expressed in equation form as:

Profits = Sales – Variable expenses – Fixed expenses

(b) Break-even point using the equation method

The break-even point is the level of sales at which profit is zero. It can also be defined as the point where total sales equals total expenses or as the point where total contribution margin equals total fixed expenses. Break-even analysis can be approached either by the equation method or by the contribution margin method. The two methods are logically equivalent.

Margin of Safety

The margin of safety is the excess of budgeted (or actual) sales over the break-even volume of sales. It is the amount by which sales can drop before losses begin to be incurred. The margin of safety can be computed in terms of dollars:

Margin of safety in dollars = Total sales – Break-even sales

Cost Structure

Cost structure refers to the relative proportion of fixed and variable costs in an organization. Understanding a company’s cost structure is important for decision-making as well as for analysis of performance.

Operating Leverage

Operating leverage is a measure of how sensitive net operating income is to a given percentage change in sales.

Assumptions in CVP Analysis

Simple CVP analysis relies on simplifying assumptions. However, if a manager knows that one of the assumptions is violated, the CVP analysis can often be easily modified to make it more realistic.

• Selling price is constant: The assumption is that the selling price of a product will not change as the unit volume changes. This is not wholly realistic since unit sales and the selling price are usually inversely related. In order to increase volume it is often necessary to drop the price. However, CVP analysis can easily accommodate more realistic assumptions. A number of examples and problems in the text show how to use CVP analysis to investigate situations in which prices are changed.
• Costs are linear and can be accurately divided into variable and fixed elements: It is assumed that the variable element is constant per unit and the fixed element is constant in total. This implies that operating conditions are stable. It also implies that the fixed costs are really fixed. When volume changes dramatically, this assumption becomes tenuous. Nevertheless, if the effects of a decision on fixed costs can be estimated, this can be explicitly taken into account in CVP analysis. A number of examples and problems in the text show how to use CVP analysis when fixed costs are affected.
• The sales mix is constant in multi-product companies: This assumption is invoked so as to use the simple break-even and target profit formulas in multi-product companies. If unit contribution margins are fairly uniform across products, violations of this assumption will not be important. However, if unit contribution margins differ a great deal, then changes in the sales mix can have a big impact on the overall contribution margin ratio and hence on the results of CVP analysis. If a manager can predict how the sales mix will change, then a more refined CVP analysis can be performed in which the individual contribution margins of products are computed.
• In manufacturing companies, inventories do not change: It is assumed that everything the company produces is sold in the same period. Violations of this assumption result in discrepancies between financial accounting net operating income and the profits calculated using the contribution approach. This topic is covered in detail in the chapter on variable costing.

Although management actions differ from organization to organization, they generally follow a four-stage management process. As illustrated at the beginning of this chapter and in the chapters that follow, the four stages of this process are:

• Planning
• Performing
• Evaluating
• Communicating

Management accounting is essential in each stage of the process as managers make business decisions.

1. Planning

Diagram below shows the overall framework in which planning takes place. The overriding goal of a business is to increase the value of the stakeholders’ interest in the business. The goal specifies the business’s end point, or ideal state. For example, Wal-Mart’s end point is “to become the worldwide leader in retailing.”

A company’s mission statement describes the fundamental way in which the company will achieve its goal of increasing stakeholders’ value. It also expresses the company’s identity and unique character.

The mission statement is essential to the planning process, which must consider how to add value through strategic objectives, tactical objectives, and operating objectives.

Strategic objectives are broad, long-term goals that determine the fundamental nature and direction of a business and that serve as a guide for decision making. Strategic objectives involve such basic issues as what a company’s main products or services will be, who its primary customers will be, and where it will operate.

Tactical objectives are mid-term goals that position an organization to achieve its long-term strategies. These objectives, which usually cover a three to five-year period, lay the groundwork for attaining the company’s strategic objectives.

Operating objectives are short-term goals that outline expectations for the performance of day-to-day operations. Operating objectives link to performance targets and specify how success will be measured.

To develop strategic, tactical, and operating objectives, managers must formulate a business plan. A business plan is a comprehensive statement of how a company will achieve its objectives. It is usually expressed in financial terms in the form of budgets, and it often includes performance goals for individuals, teams, products, or services

2. Performing

Planning alone does not guarantee satisfactory operating results. Management must implement the business plan in ways that make optimal use of available resources in an ethical manner. Smooth operations require one or more of the following:-

• Hiring and training personnel
• Matching human and technical resources to the work that must be done
• Purchasing or leasing facilities
• Maintaining an inventory of products for sale
• Identifying operating activities, or tasks, that minimize waste and improve the quality of products or services

Critical to managing any retail business is a thorough understanding of its supply chain. The supply chain is the path that leads from the suppliers of the material to its final consumers. The supply chain expresses the links between businesses growers to vendors to the business to their customers.

3. Evaluating

When managers evaluate operating results, they compare the organization’s actual performance with the performance levels they established in the planning stage. They earmark any significant variations for further analysis so that they can correct the problems. If the problems are the result of a change in the organization’s operating environment, the managers may revise the original objectives. Ideally, the adjustments made in the evaluation stage will improve the company’s performance.

4. Communicating

Whether accounting reports are prepared for internal or external use, they must provide accurate information and clearly communicate this information to the reader. Inaccurate or confusing internal reports can have a negative effect on a company’s operations. Full disclosure and transparency in financial statements issued to external parties is a basic concept of generally accepted accounting principles, and violation of this principle can result in stiff penalties.

Management Accounting also known as Managerial Accounting is the accounting for managers which helps the management of the organization to formulate policies and forecasting, planning and controlling the day to day business operations of the organization. Both the quantitative and qualitative information are captured and analyzed by the management accounting.

The functional area of management accounting is not limited to providing a financial or cost information only. Instead, it extracts the relevant and material information from financial and cost accounting to assist the management in budgeting, setting goals, decision making, etc. The accounting can be done as per the requirement of the management, i.e. weekly, monthly, quarterly, etc. and there is no format set on the basis of which it is to be reported.

Financial Accounting

Financial Accounting is an accounting system which is concerned with the preparation of financial statement for the outside parties like creditors, shareholders, investors, suppliers, lenders, customers, etc. It is the purest form of accounting in which proper record keeping and reporting of financial data are done, to provide relevant and material information to its users.

Financial Accounting is based on various assumptions, principles and convention like going concern, materiality, matching, realisation, conservatism, consistency, accrual, historical cost, etc. The financial statement consists of a Balance Sheet, Income Statement and Cash flow statement which are prepared as per the guidelines provided by the relevant statute.

Normally, the statements based on the financial accounting are prepared for one accounting year, to enable the user to make comparisons regarding the financial position, profitability and performance of the company in a specific period. Not only external parties but internal management also gets information for forecasting, planning, and decision making.

A common question is to explain the differences between financial accounting and managerial accounting, since each one involves a distinctly different career path. In general, financial accounting refers to the aggregation of accounting information into financial statements, while managerial accounting refers to the internal processes used to account for business transactions. There are a number of differences between financial and managerial accounting, which fall into the following categories:

1. Aggregation

Financial accounting reports on the results of an entire business. Managerial accounting almost always reports at a more detailed level, such as profits by product, product line, customer, and geographic region.

2. Efficiency

Financial accounting reports on the profitability (and therefore the efficiency) of a business, whereas managerial accounting reports on specifically what is causing problems and how to fix them.

3. Proven information

Financial accounting requires that records be kept with considerable precision, which is needed to prove that the financial statements are correct. Managerial accounting frequently deals with estimates, rather than proven and verifiable facts.

4. Reporting focus

Financial accounting is oriented toward the creation of financial statements, which are distributed both within and outside of a company. Managerial accounting is more concerned with operational reports, which are only distributed within a company.

5. Standards

Financial accounting must comply with various accounting standards, whereas managerial accounting does not have to comply with any standards when information is compiled for internal consumption.

6. Systems

Financial accounting pays no attention to the overall system that a company has for generating a profit, only its outcome. Conversely, managerial accounting is interested in the location of bottleneck operations, and the various ways to enhance profits by resolving bottleneck issues.

7. Time period

Financial accounting is concerned with the financial results that a business has already achieved, so it has a historical orientation. Managerial accounting may address budgets and forecasts, and so can have a future orientation.

8. Timing

Financial accounting requires that financial statements be issued following the end of an accounting period. Managerial accounting may issue reports much more frequently, since the information it provides is of most relevance if managers can see it right away.

9. Valuation

Financial accounting addresses the proper valuation of assets and liabilities, and so is involved with impairments, revaluations, and so forth. Managerial accounting is not concerned with the value of these items, only their productivity.

There is also a difference in the accounting certifications typically found in each of these areas. People with the Certified Public Accountant designation have been trained in financial accounting, while those with the Certified Management Accountant designation have been trained in managerial accounting.

a. Define the Investment Goals

What is the purpose of my investment? Answer to this should be the foundation of your mutual fund choices. For instance, if you want a regular income with capital protection, you can choose to invest in a debt fund. However, if you have a higher risk appetite and an aim to build your wealth, equities will suit your purpose. So it is crucial to define your financial goal first and then decide your investment. This also has a pivotal role in fund evaluation.

b. Shortlist a few peer Funds to compare

It is difficult to assess a mutual fund in isolation. So, you should always make a small list of comparable funds and continuously compare them. There are many FinTech firms and third party websites that offer free mutual fund screener tools.

c. Check the historical Performance Data

Now every mutual fund handbook comes with a disclaimer stating that past performance is no indicator of future performance. However, this data can help you check how the fund has fared across different market cycles. Consistency can also shed light on the skill of the fund manager. In short, it will be easier for you to find a fund with lower risks but higher returns.

d. Fee Structure of the Fund

A mutual fund company charges you for its services and expertise. Some funds require deft management and quick decisions on whether to buy, sell or hold on to an asset. Please remember that a fund with a higher fee is automatically better. Do check out other parameters too before choosing.

e. Risk-Adjusted Returns

Every fund expects certain risks related to the market and the industry. When fund strategies in such a way that they make more returns against anticipated risks, we call them risk-adjusted returns.

f. Performance against Index

Indexes like Nifty, BSE Sensex and BSE 200 set benchmarks, and all fund performances are evaluated on this basis. Comparing different timelines against the benchmark as well as peers, can be insightful. A well-managed fund won’t fall too hard during a market low.

Why track the Investment Performance

You might have seen the disclaimer that past performance does not indicate the future performance of a fund’. It means that you cannot expect guaranteed returns on investment. Therefore, you need to look beyond the previous years’ returns to assess a mutual fund. Primarily, you should monitor your investments so that you can make informed decisions that can lead to higher returns.

You know that the capital market keeps fluctuating with changes in the overall economic conditions. Such a change disturbs the asset allocation of the portfolio. For instance, an original allocation of 50:50 in equity and debt may change to 60:40 owing to a market rally. It may increase the risk profile of the fund beyond your requirements. Fund evaluation also helps you to compare the performance of your investment against other similar funds. Additionally, a change in fund manager or fundamental attributes of your fund may also trigger an evaluation. Hence, a review and rebalancing might be required to keep the risk profile of the portfolio intact.

How often to Evaluate Fund Performance

The market is subject to fluctuations. However, that doesn’t mean you need to assess the fund performance daily. Ideally, you should evaluate your fund every six months to a year, depending on the tenure of the investment. Evaluating the funds in a shorter period does not give an accurate insight into the performance of your investments. If all this sounds too much, you may invest in regular funds. As qualified intermediaries, they advise you to invest in funds based on your financial goals and risk profile.

Financial Ratios & Fund Performance 

While you may have taken due diligence and advice before investing, you still need to track the performance of your funds. The easiest way to do it is by using the fund fact sheet. In simple terms, the fund fact sheet shows the performance of all the schemes managed by your fund house, including your investment. You must compare these financial ratios with the mutual fund schemes in the same category to understand where your fund stands.

a. Alpha

The fund’s Alpha gives an overview of the fund manager’s skills and strategies and how they fared in the past. It should always be higher than the expense ratio of the fund. Additionally, your fund’s Alpha needs to be higher than the peers, which are at a similar level of beta.

b. Expense Ratio

This is essentially the fee for the fund house for managing your mutual fund. Expense ratios reflects the value-for-money aspect of a fund. It consists of fund management charges and all the other costs related to that of fund management. It impacts your ultimate take-home returns.

c. Benchmark

It is always advisable to compare the fund performance against the benchmark. The benchmark acts as a standard for funds’ performance. If your fund is outperforming the benchmark consistently, it is a sign that the fund is doing well. You can also compare the average return during a specific time frame with its peer funds in the same category.

d. Portfolio Holdings

Look for considerable changes and probable overlapping in the portfolio holdings. The fund needs to hold good quality stocks which have a lower Price to Earnings-per-share (P/E) Ratio vis-a-vis Price to Book Value (P/B) ratio. Additionally, ensure that the fund is investing as per its investment objective. For instance, fund having a high portfolio turnover ratio vis-a-vis lower returns is a bad indicator.

e. Sharpe Ratio

This ratio shows how much extra return you receive for the additional risks you undertake. It is a rule of thumb that higher risks must be compensated more. Moreover, you deserve a reward (excess returns) for the added volatility. Sharpe Ratio tells you how much exactly that reward should be.

Most Mutual Funds invest in 50 to 100 different investments based on market capitalisation, sectors and many other demographics. Only on a rare occasion do all stocks decline at the same time and in the same proportion. Hence, Mutual Funds offer a diversified investment portfolio even with a small amount of investment that would otherwise require big capital. Even with big capital, it is extremely difficult and time-consuming to purchase and manage a wide range of investments individually.

While investing in few shares or debentures directly is possible, the risk of potential loss is all on the investor. However, Mutual Funds reduce the risk of loss as the portfolio is largely diversified and the purchases are backed by research and experience of the fund house. Moreover, the loss is also shared with other investors in the same fund. This diversification of risk is one of the key benefits of a collective investment instrument like mutual funds.

Only Sector funds invest across one industry making them less diversified and therefore more volatile.

Professional Management

Mutual Fund schemes are managed by qualified experienced professionals who work towards the fund’s defined objective. These financial experts are accompanied by a specialized investment research team. The experts and their teams diligently and judiciously study companies, their products and performance. After thorough analysis, the best investment option most aptly suited to achieve the scheme’s objective is chosen. This continuous process adds value to your investment and helps obtain higher returns.

While, investors may differ in their investment needs based on their financial goals, currently, they have over 8000+ schemes to choose from to meet their goals. Therefore, mutual funds make the best way one can invest in Equities, Debt or Commodities (mainly Gold)

Affordability

A mutual fund invests generally buy and sell various asset classes in large volumes allowing investors to benefit from lower trading costs. Investors can get exposure to such portfolios with an investment as modest as Rs.500/-* in mutual funds through a Systematic Investment Plan. Such portfolio would otherwise be extremely expensive to purchase and maintain for an investor investing directly in stock market.

Liquidity

With open ended funds, investors can redeem (encash) all or part of their investments at prevailing net asset value, at any point of time. Mutual Funds are more liquid than most investments in shares, deposits, and bonds. In addition, a standardised process enables quick and efficient redemption allowing investors to get cash in hand as soon as possible. For closed ended schemes, investors can redeem their investments at prevailing Net Asset Value, subject to exit load at specific intervals, if provided in the scheme. In certain schemes, where lock in period is mentioned, investor cannot redeem his investment until that period.

Transparency

Mutual Funds are the most transparent form of investment. Investors receive detailed information and timely updates about the nature of investments made, fund manager’s investment strategy behind the investments, the exact amount invested in each type of security, etc. Moreover, the performance of a Mutual Fund is reviewed by various publications and rating agencies, making it easy for investors to compare one fund to another.

Rupee-cost Averaging

Rupee cost averaging or SIP provides the investor a disciplined approach of investing specific amount at regular intervals regardless of the unit price of the investment. Therefore, the money invested fetches more units when the price is low and lesser when the price is high. Thus, allowing you to achieve a lower average cost per unit over time. The strategy helps smoothen out market ups and downs in the long run, while reducing the risk of investing in volatile markets.

Regulations

All Mutual Funds are required to register with Securities Exchange Board of India (SEBI). With investor interest at the helm, SEBI has laid down strict regulations to safeguard investors against possible frauds. It is even mandatory for Mutual Fund distributors to register with Association of Mutual Funds in India (AMFI) and abide the norms laid by the Securities and Exchange Board of India (SEBI) and AMFI for the distributors.

Choice of Investment

Mutual Funds are the only product category that caters to every one’s needs. You will always find a mutual fund that matches your time horizon long, medium, or short; and your risk-taking ability low, medium, high. All this irrelevant of how much you invest, be it a very small investment or a huge Lumpsum. Your adviser will help choose the right fund/s for you keeping in mind your profile.

Minimizing Costs

Mutual Funds help investors to benefit from economies of scale as mutual funds pool money from vast number people with common interest and invest their money in the relevant asset class/classes. This helps the investors share the cost of management of their money.

The Securities and Exchange Board of India (SEBI) is the regulator for the securities market in India. It was established in 1988 and given statutory powers on 30 January 1992 through the SEBI Act, 1992.

Initially SEBI was a non statutory body without any statutory power. However, in 1992, the SEBI was given additional statutory power by the Government of India through an amendment to the Securities and Exchange Board of India Act, 1992. In April 1988 the SEBI was constituted as the regulator of capital markets in India under a resolution of the Government of India.

Its main objective was to promote orderly and healthy growth of securities and to provide protection to the investors.

The main objective is to create such an environment which facilitates efficient mobilization and allocation of resources through the securities market. This environment consists of rules and regulations, policy framework, practices and infrastructures to meet the needs of three groups which mainly constitute the market i.e. issuers of securities (companies), the investors and the market intermediaries.

(i) To the Issuers

SEBI aims to provide a market place to the issuers where they can confidently look forward to raise the required amount of funds in an easy and efficient manner.

(ii) To the Investors

SEBI aims to protect the right and interest of the investors by providing adequate, accurate and authentic information on a regular basis.

(iii) To the Intermediaries

In order to enable the intermediaries to provide better service to the investors and the issuers, SEBI provides a competitive, professionalized and expanding market to them having adequate and efficient infrastructure.

Sebi Guidelines

(1) Formation:

Certain structural changes have also been made in the mutual fund industry, as part of which mutual funds are required to set up asset management companies with fifty percent independent directors, separate board of trustee companies, consisting of a minimum fifty percent of independent trustees and to appoint independent custodians.

This is to ensure an arm’s length relationship between trustees, fund managers and custodians, and is in contrast with the situation prevailing earlier in which all three functions were often performed by one body which was usually the sponsor of the fund or a subsidiary of the sponsor.

Thus, the process of forming and floating mutual funds has been made a tripartite exercise by authorities. The trustees, the asset management companies (AMCs) and the mutual fund shareholders form the three legs. SEBI guidelines provide for the trustees to maintain an arm’s length relationship with the AMCs and do all those things that would secure the right of investors.

With funds being managed by AMCs and custody of assets remaining with trustees, an element of counter-balancing of risks exists as both can keep tabs on each other.

(2) Registration:

In January 1993, SEBI prescribed registration of mutual funds taking into account track record of a sponsor, integrity in business transactions and financial soundness while granting permission.

This will curb excessive growth of the mutual funds and protect investor’s interest by registering only the sound promoters with a proven track record and financial strength. In February 1993, SEBI cleared six private sector mutual funds viz. 20th Century Finance Corporation, Industrial Credit & Investment Corporation of India, Tata Sons, Credit Capital Finance Corporation, Ceat Financial Services and Apple Industries.

(3) Documents:

The offer documents of schemes launched by mutual funds and the scheme particulars are required to be vetted by SEBI. A standard format for mutual fund prospectuses is being formulated.

(4) Code of advertisement:

Mutual funds have been required to adhere to a code of advertisement.

(5) Assurance on returns:

SEBI has introduced a change in the Securities Control and Regulations Act governing the mutual funds. Now the mutual funds were prevented from giving any assurance on the land of returns they would be providing. However, under pressure from the mutual funds, SEBI revised the guidelines allowing assurances on return subject to certain conditions.

Hence, only those mutual funds which have been in the market for at least five years are allowed to assure a maximum return of 12 per cent only, for one year. With this, SEBI, by default, allowed public sector mutual funds an advantage against the newly set up private mutual funds.

As per basic tenets of investment, it can be justifiably argued that investments in the capital market carried a certain amount of risk, and any investor investing in the markets with an aim of making profit from capital appreciation, or otherwise, should also be prepared to bear the risks of loss.

(6) Minimum corpus:

The current SEBI guidelines on mutual funds prescribe a minimum start-up corpus of Rs.50 crore for a open-ended scheme, and Rs.20 crore corpus for closed-ended scheme, failing which application money has to be refunded.

The idea behind forwarding such a proposal to SEBI is that in the past, the minimum corpus requirements have forced AMCs to solicit funds from corporate bodies, thus reducing mutual funds into quasi-portfolio management outfits. In fact, the Association of Mutual Funds in India (AMFI) has repeatedly appealed to the regulatory authorities for scrapping the minimum corpus requirements.

(7) Institutionalisation:

The efforts of SEBI have, in the last few years, been to institutionalise the market by introducing proportionate allotment and increasing the minimum deposit amount to Rs.5000 etc. These efforts are to channel the investment of individual investors into the mutual funds.

(8) Investment of funds mobilised:

In November 1992, SEBI increased the time limit from six months to nine months within which the mutual funds have to invest resources raised from the latest tax saving schemes. The guideline was issued to protect the mutual funds from the disadvantage of investing funds in the bullish market at very high prices and suffering from poor NAV thereafter.

(9) Investment in money market:

SEBI guidelines say that mutual funds can invest a maximum of 25 per cent of resources mobilised into money-market instruments in the first six months after closing the funds and a maximum of 15 per cent of the corpus after six months to meet short term liquidity requirements.

Private sector mutual funds, for the first time, were allowed to invest in the call money market after this year’s budget. However, as SEBI regulations limit their exposure to money markets, mutual funds are not major players in the call money market. Thus, mutual funds do not have a significant impact on the call money market.

(10) Valuation of investment:

The transparent and well understood declaration or Net Asset Values (NAVs) of mutual fund schemes is an important issue in providing investors with information as to the performance of the fund. SEBI has warned some mutual funds earlier of unhealthy market

(11) Inspection:

SEBI inspect mutual funds every year. A full SEBI inspection of all the 27 mutual funds was proposed to be done by the March 1996 to streamline their operations and protect the investor’s interests. Mutual funds are monitored and inspected by SEBI to ensure compliance with the regulations.

(12) Underwriting:

In July 1994, SEBI permitted mutual funds to take up underwriting of primary issues as a part of their investment activity. This step may assist the mutual funds in diversifying their business.

(13) Conduct:

In September 1994, it was clarified by SEBI that mutual funds shall not offer buy back schemes or assured returns to corporate investors. The Regulations governing Mutual Funds and Portfolio Managers ensure transparency in their functioning.

(14) Voting rights:

In September 1993, mutual funds were allowed to exercise their voting rights. Department of Company Affairs has reportedly granted mutual funds the right to vote as full-fledged shareholders in companies where they have equity investments.

SEBI objectives

(1) Regulation of Stock Exchanges:

The first objective of SEBI is to regulate stock exchanges so that efficient services may be provided to all the parties operating there.

(2) Protection to the Investors:

The capital market is meaningless in the absence of the investors. Therefore, it is important to protect the interests of the investors.

The protection of the interests of the investors means protecting them from the wrong information given by the companies in their prospectus, reducing the risk of delivery and payment, etc. Hence, the foremost objective of the SEBI is to provide security to the investors.

(3) Checking the Insider Trading:

Insider trading means the buying and selling of securities by those people’s directors Promoters, etc. who have some secret information about the company and who wish to take advantage of this secret information.

This hurts the interests of the general investors. It was very essential to check this tendency. Many steps have been taken to check inside trading through the medium of the SEBI.

(4) Control over Brokers:

It is important to keep an eye on the activities of the brokers and other middlemen in order to control the capital market. To have a control over them, it was necessary to establish the SEBI.

Mutual Fund industry plays a key role in the Indian Financial Sector. This industry has come a long way since its inception in the year 1963. The expansion of this sector has been tremendous as it has seen growth in all parameters namely assets under management, number of schemes, funds, fund houses etc. Investing in mutual fund has seen an upfront growth in India because of the nature of this instrument. Mutual fund is a type of financial intermediary that empowers million small as well as large investors across the country to participate and invest in capital market and derive benefits from it. Let us understand more about mutual fund, its history and growth in India.

Growth of mutual fund industry in India

Internationally, the dawn of mutual fund industry was witnessed in 19th century in Europe. It was Robert Fleming who set up the first ever mutual fund company called as ‘foreign and colonial investment trust’ in 1868 who promised to invest and overlook the finances of the investors. While in India, the introduction of mutual fund came a lot later. The journey of mutual fund in India started in the 1963 with the incorporation of ‘Unit Trust of India (UTI)’. The growth of mutual fund in India has happened in phased manner as under:

• Phase 1: Formation and Growth of UTI (1964 to 1987) The phase 1 witnessed the incorporation and introduction of Unit Trust of India by passing an Act by Parliament. The incorporation of UTI was done by Reserve Bank of India. Post its incorporation, it was the only institution that accepted investments and offered mutual fund units. The first scheme launched by UTI was the Unit Scheme in the year 1964. Later in the years of 70s and 80s, UTI introduced various schemes as per the needs of Indian investors. The first ULIP (Unit Linked Insurance Plan) was introduced by UTI in the year 1971, while the 1st Indian Offshore Fund was launched in the year 1986. In this phase i.e. from the date of inception to the year 1987, the growth of UTI multiplied tremendously.
• Phase 2: Establishment of Public Sector Funds (1987 to 1992) The year 1987 witnessed the establishment of public sector funds i.e. other public sector institutions like banks and NBFCs were allowed to start mutual fund houses. This resulted in opening up of economy and State Bank of India was the first bank to establish a mutual fund company in the year 1987. The footsteps of SBI were then followed by various other institutions like Canbank, Life Insurance Corporation of India, Indian Bank, Bank of India, General Insurance Corporation of India and Punjab National Bank introducing their own mutual fund companies. During this period, the asset under management under this sector increased from Rs. 6700 Crores to a whooping Rs. 47004 Crores as investors in India showed great interest in this financial tool and started investing a large part of their salary in Mutual funds.
• Phase 3: Introduction of Private Sector Funds (1992 to 1997) After the successful introduction of Public Sector Funds, the mutual fund industry opened up and witnessed the establishment of private sector funds from the year 1993, giving Indian investors the extensive opportunity to choose mutual funds from public and private sector. On the other hand, it increased the competition for Indian mutual fund companies.
• Phase 4: Growth and introduction of SEBI regulations (1997 to 1999) As the mutual fund sector was witnessing and achieving newer heights, it was important to create a body that created comprehensive rules and regulation for this industry and creating a responsible organisation to overlook the working of this sector. This gave birth to incorporation of SEBI Regulation in 1996. SEBI introduced standardization and set uniform rules and regulations for all funds. It was during this phase that SEBI and AMFI launched an awareness scheme for investors of mutual funds.
• Phase 5: Emergence of a Large and Stable Industry (1999 to 2004) This phase witnessed the integration of the entire industry with a similar set of rules and regulations. The uniform and standardized operations and regulations made it easier for investors to invest in various mutual fund companies resulting in increase of asset under management from Rs. 68000 crores in previous phase to over Rs. 1.50 lakh crores during this phase.
• Phase 6: Amalgamation and Growth (2004 onwards) The mutual fund industry has seen immense growth and globalisation since the day of its incorporation. From the year 2004, this industry witnessed integration as there were many mergers, demergers and acquisitions of companies and schemes like Allianz Mutual Fund taken over by Birla Sun Life, PNB mutual fund by Principal etc. Thus, since the year 2004, this industry is coping and integrating new players, dealing with mergers and acquisitions and continuing its journey towards growth.

Structure of Mutual Funds in India

Let us understand the structure and working of best mutual fund to invest in India. The structure of mutual funds in India is designed by SEBI, thus determining it to be very well crafted and regulated. The regulations laid by SEBI has made the operations and working of this industry very transparent and SEBI working closely towards protecting the investor’s interest. The mutual fund industry operates on 4 tier structure as under:

• Sponsor: A sponsor is a corporate body acting alone or with another corporate body who establishes the mutual fund. This sponsor must contribute to 40% to the asset management companies’ net worth.
• Board of Trustees: Board of trustee is an independent third-party board who are responsible to working towards protecting the interest of the unit-holders by holding and overlooking the property owned by the mutual fund.
• Asset Management Company (AMC): The AMC are the fund managers of the investor. This body is responsible to invest the investor’s money in various capital market instruments.
• Custodian: The SEBI regulation specifies that all mutual funds must park their securities with SEBI registered custodian bank.

Over decades, the Indian Mutual Fund Industry has seen a lot of development and growth. It has become more organized and transparent in terms of its functioning, since the inception few mutual fund companies have been offering top notch mutual fund schemes. If you wish to invest in mutual funds, you can invest in these top equity funds of 2019: SBI Bluechip Fund, SBI Magnum Multicap Fund, Axis Bluechip Fund, ICICI Prudential Bluechip Fund, UTI-ST Income fund.

A money market fund (also called a money market mutual fund) is an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are managed with the goal of maintaining a highly stable asset value through liquid investments, while paying income to investors in the form of dividends. Although they are not insured against loss, actual losses have been quite rare in practice.

Money market mutual funds (MMF) invest in short-term debt instruments, cash, and cash equivalents that are rated high quality. It is for this reason that money market mutual funds are considered safe or investment with minimal to low risk. As these funds invest in high-quality instruments, they offer a predictable risk-free return rate.

Money market mutual funds (MMMF) are used to manage short-term cash needs. These funds are open-ended in the debt fund category and deal only in cash or cash equivalents. Money market securities have an average maturity of one-year; that is why these are termed as money market instruments.

The fund manager invests in high-quality liquid instruments such as treasury bills (T-Bills), repurchase agreements (Repos), commercial papers, and certificates of deposit. Money market funds mainly target earning interest for the unitholders. The primary aim of money market funds is to minimise the fluctuation of the Net Asset Value (NAV) of the fund.

Types of Money Market Instruments

Following are the most popular money market instruments:

1. Certificate of Deposit (CD)
   These are time deposits such as fixed deposits that are offered by scheduled commercial banks. The only difference between FD and CD is that investors are not allowed to withdraw CD until maturity.
2. Commercial Paper (CPs)
   These are issued by companies and financial institutions which have a high credit rating. Commercial papers are also known as promissory notes, commercial papers are unsecured instruments, which are issued at the discounted rate and redeemed at face value.
3. Treasury Bills (T-bills)
   T-bills are issued by the Government of India to raise money for a short-term of up to 365 days. Treasury bills are considered one of the safest instruments as the government backs these. The rate of return, also known as the risk-free rate, is low on T-bills as compared to all other instruments.
4. Repurchase Agreements (Repos)
   It is an agreement under which RBI lends money to commercial banks. It involves the sale and purchase of agreement at the same time.

A money market fund tries to offer the highest short-term income by maintaining a well-diversified portfolio of money market instruments. Investors having a short investment horizon of up to one year may invest in these funds.

Those individuals with low-risk appetite having their surplus cash parked in a savings bank account can invest in money market funds. These funds have the potential to offer higher returns than a regular savings bank account. The investors could be corporate as well as retail investors.

If you have a medium to long-term investment horizon, then money market fund won’t be an ideal option. Instead, you may go for dynamic bond funds or balanced funds, which are capable of providing relatively higher returns.

Things to Consider as an Investor

1. Risk
   Money market funds face interest rate risk, credit risk, and reinvestment risk. In interest rate risk, the prices of the underlying asset increases as interest rates decline and decrease as interest rates rise. The fund manager may invest in risky securities which have a higher probability of default.
2. Return
   Money market funds have the potential to offer higher returns than a regular savings bank account. However, the returns are not guaranteed. The Net asset value (NAV) fluctuates with changes in the overall interest rate regime. A fall in interest rates may increase the prices of an underlying asset and deliver good returns.
3. Costs
   Expense ratio refers to the fee charged by fund houses to manage your investment. SEBI has capped the expense ratio at 1.05%. As the assets under management (AUM) increases, the scheme tends to reduce the cost of operations.
4. Investment Horizon
   Money market funds are suitable for very short-term to short-term investment horizons, i.e. three months to one year. For medium-term horizons, you may invest in other debt funds like dynamic bond funds.
5. Financial Goals
   If you have to make EMI payments or invest extra cash while maintaining liquidity, then you can use money market funds. A small portion of your portfolio can be invested in these for diversification.
6. Tax on Gains
   Investing in debt funds provides you with taxable capital gains. The tax rate depends on the holding period, i.e. for how long you stayed invested in the fund. You make a Short-term Capital Gain (STCG) when you stay invested for a period of fewer than three years.

Long-term Capital Gains (LTCG) are made when you stay invested for over three years. STCG from money market funds are added to your income and taxed according to your income slab. LTCG from money market funds is taxed at the flat rate of 20% after indexation.

Insurance is a co-operative device to spread the loss caused by a particular risk over a number of persons, who are exposed to it and who agree to insure themselves against the risk.

Thus, the insurance is (a) a co-operative device to spread the risk; (b) the system to spread the risk over a number of persons who are insured against the risk; (c) the principle to share the loss of each member of the society on the basis of probability of loss to their risk; and (d) the method to provide security against losses to the insured.

Similarly another definition can be given. Insurance is a co-operative device of distributing losses, falling on an individual or his family over a large number of persons, each bearing a nominal expenditure and feeling secure against heavy loss.

Contractual Definition:

Insurance has been defined to be that in which a sum of money as a premium is paid in consideration of the insurer’s incurring the risk of paying a large sum upon a given contingency.

The insurance, thus, is a contract whereby (a) certain sum, called premium, is charged in consideration, (b) against the said consideration, a large sum is guaranteed to be paid by the insurer who received the premium, (c) the payment will be made in a certain definite sum, i.e., the loss or the policy amount whichever may be, and (d) the payment is made only upon a contingency.

More specific definition can be given as follows Insurance may be defined as a consisting one party (the insurer) agrees to pay to the other party (the insurer) or his beneficiary, a certain sum upon a given contingency (the risk) against which insurance is sought.

The insurance has the following characteristics which are, generally, observed in case of life, marine, fire and general insurances.

1. Sharing of Risk:

Insurance is a device to share the financial losses which might befall on an individual or his family on the happening of a specified event. The event may be death of a bread-winner to the family in the case of life insurance, marine-perils in marine insurance, fire in fire insurance and other certain events in general insurance, e.g., theft in burglary insurance, accident in motor insurance, etc. The loss arising nom these events if insured are shared by all the insured in the form of premium.

2. Co-operative Device:

The most important feature of every insurance plan is the co-operation of large number of persons who, in effect, agree to share the financial loss arising due to a particular risk which is insured. Such a group of persons may be brought together voluntarily or through publicity or through solicitation of the agents.

An insurer would be unable to compensate all the losses from his own capital. So, by insuring or underwriting a large number of persons, he is able to pay the amount of loss. Like all co­operative devices, there is no compulsion here on anybody to purchase the insurance policy.

3. Value of Risk:

The risk is evaluated before insuring to charge the amount of share of an insured, herein called, consideration or premium. There are several methods of evaluation of risks. If there is expectation of more loss, higher premium may be charged. So, the probability of loss is calculated at the time of insurance.

4. Payment at Contingency:

The payment is made at a certain contingency insured. If the contingency occurs, payment is made. Since the life insurance contract is a contract of certainty, because the contingency, the death or the expiry of term, will certainly occur, the payment is certain. In other insurance contracts, the contingency is the fire or the marine perils etc., may or may not occur. So, if the contingency occurs, payment is made, otherwise no amount is given to the policy-holder.

Similarly, in certain types of life policies, payment is not certain due to uncertainty of a particular contingency within a particular period. For example, in term-insurance then, payment is made only when death of the assured occurs within the specified term, may be one or two years. Similarly, in Pure Endowment payment is made only at the survival of the insured at the expiry of the period.

5. Amount of Payment:

The amount of payment depends upon the value of loss occurred due to the particular insured risk provided insurance is there up to that amount. In life insurance, the purpose is not to make good the financial loss suffered. The insurer promises to pay a fixed sum on the happening of an event.

If the event or the contingency takes place, the payment does fall due if the policy is valid and in force at the time of the event, like property insurance, the dependents will not be required to prove the occurring of loss and the amount of loss. It is immaterial in life insurance what was the amount of loss at the time of contingency. But in the property and general insurances, the amount of loss as well as the happening of loss, are required to be proved.

6. Large Number of Insured Persons

To spread the loss immediately, smoothly and cheaply, large number of persons should be insured. The co-operation of a small number of persons may also be insurance but it will be limited to smaller area. The cost of insurance to each member may be higher. So, it may be unmarketable.

Therefore, to make the insurance cheaper, it is essential to insure large number of persons or property because the lesser would be cost of insurance and so, the lower would be premium. In past years, tariff associations or mutual fire insurance associations were found to share the loss at cheaper rate. In order to function successfully, the insurance should be joined by a large number of persons.

7. Insurance is not a gambling:

The insurance serves indirectly to increase the productivity of the community by eliminating worry and increasing initiative. The uncertainty is changed into certainty by insuring property and life because the insurer promises to pay a definite sum at damage or death.

From a family and business point of view all lives possess an economic value which may at any time be snuffed out by death, and it is as reasonable to ensure against the loss of this value as it is to protect oneself against the loss of property. In the absence of insurance, the property owners could at best practice only some form of self-insurance, which may not give him absolute certainty.

Similarly, in absence of life insurance, saving requires time; but death may occur at any time and the property, and family may remain unprotected. Thus, the family is protected against losses on death and damage with the help of insurance.

From the company’s point of view, the life insurance is essentially non-speculative; in fact, no other business operates with greater certainties. From the insured point of view, too, insurance is also the antithesis of gambling. Nothing is more uncertain than life and life insurance offers the only sure method of changing that uncertainty into certainty.

Failure of insurance amounts gambling because the uncertainty of loss is always looming. In fact, the insurance is just the opposite of gambling. In gambling, by bidding the person exposes himself to risk of losing, in the insurance; the insured is always opposed to risk, and will suffer loss if he is not insured.

By getting insured his life and property, he protects himself against the risk of loss. In fact, if he does not get his property or life insured he is gambling with his life on property.

8. Insurance is not Charity:

Charity is given without consideration but insurance is not possible without premium. It provides security and safety to an individual and to the society although it is a kind of business because in consideration of premium it guarantees the payment of loss. It is a profession because it provides adequate sources at the time of disasters only by charging a nominal premium for the service.

Primary and Secondary Functions of insurance

Insurance is defined as a co-operative device to spread the loss caused by a particular risk over a number of persons who are exposed to it and who agree to ensure themselves against that risk. Risk is uncertainty of a financial loss. It should not be confused with the chance of loss which is the probable number of losses out of a given number of exposures.

It should not be confused with peril which is defined as the cause of loss or with hazard which is a condition that may increase the chance of loss.

Finally, risk must not be confused with loss itself which is the unintentional decline in or disappearance of value arising from a contingency. Wherever there is uncertainty with respect to a probable loss there is risk.

Every risk involves the loss of one or other kind. The function of insurance is to spread the loss over a large number of persons who are agreed to co-operate each other at the time of loss. The risk cannot be averted but loss occurring due to a certain risk can be distributed amongst the agreed persons. They are agreed to share the loss because the chances of loss, i.e., the time, amount, to a person are not known.

Anybody of them may suffer loss to a given risk, so, the rest of the persons who are agreed will share the loss. The larger the number of such persons the easier the process of distribution of loss, In fact; the loss is shared by them by payment of premium which is calculated on the probability of loss.

In olden time, the contribution by the persons was made at the time of loss. The insurance is also defined as a social device to accumulate funds to meet the uncertain losses arising through a certain risk to a person insured against the risk.

The functions of insurance can be studied into two parts (i) Primary Functions, and (ii) Secondary Functions.

Primary Functions:

(i) Insurance provides certainty:

Insurance provides certainty of payment at the uncertainty of loss. The uncertainty of loss can be reduced by better planning and administration. But, the insurance relieves the person from such difficult task. Moreover, if the subject matters are not adequate, the self-provision may prove costlier.

There are different types of uncertainty in a risk. The risk will occur or not, when will occur, how much loss will be there? In other words, there are uncertainty of happening of time and amount of loss. Insurance removes all these uncertainty and the assured is given certainty of payment of loss. The insurer charges premium for providing the said certainty.

(ii) Insurance provides protection:

The main function of the insurance is to provide protection against the probable chances of loss. The time and amount of loss are uncertain and at the happening of risk, the person will suffer loss in absence of insurance. The insurance guarantees the payment of loss and thus protects the assured from sufferings. The insurance cannot check the happening of risk but can provide for losses at the happening of the risk.

(iii) Risk-Sharing:

The risk is uncertain, and therefore, the loss arising from the risk is also uncertain. When risk takes place, the loss is shared by all the persons who are exposed to the risk. The risk-sharing in ancient time was done only at time of damage or death; but today, on the basis of probability of risk, the share is obtained from each and every insured in the shape of premium without which protection is not guaranteed by the insurer.

Secondary functions:

Besides the above primary functions, the insurance works for the following functions:

(i) Prevention of Loss:

The insurance joins hands with those institutions which are engaged in preventing the losses of the society because the reduction in loss causes lesser payment to the assured and so more saving is possible which will assist in reducing the premium. Lesser premium invites more business and more business cause lesser share to the assured.

So again premium is reduced to, which will stimulate more business and more protection to the masses. Therefore, the insurance assist financially to the health organisation, fire brigade, educational institutions and other organisations which are engaged in preventing the losses of the masses from death or damage.

(ii) It Provides Capital:

The insurance provides capital to the society. The accumulated funds are invested in productive channel. The dearth of capital of the society is minimised to a greater extent with the help of investment of insurance. The industry, the business and the individual are benefited by the investment and loans of the insurers.

(iii) It Improves Efficiency:

The insurance eliminates worries and miseries of losses at death and destruction of property. The carefree person can devote his body and soul together for better achievement. It improves not only his efficiency, but the efficiencies of the masses are also advanced.

(iv) It helps Economic Progress:

The insurance by protecting the society from huge losses of damage, destruction and death, provides an initiative to work hard for the betterment of the masses. The next factor of economic progress, the capital, is also immensely provided by the masses. The property, the valuable assets, the man, the machine and the society cannot lose much at the disaster.

1. Term insurance plan

As the name says Term insurance plan are those plan that is purchased for a fixed period of time, say 10, 20 or 30 years. As these policies don’t carry any cash value their policies do not carry any maturity benefits, hence their policies are cheaper as compared to other policies. This policy turns beneficial only on the occurrence of the event.

2. Endowment policy

The only difference between the term insurance plan and the endowment policy is that endowment policy comes with the extra benefit that the policyholder will receive a lump sum amount in case if he survives until the date of maturity. Rest details of term policy are same and also applicable to an endowment policy.

3. Unit Linked Insurance Plan

These plans offer policyholder to build wealth in addition to life security. Premium paid into this policy is bifurcated into two parts, one for the purpose of Life insurance and another for the purpose of building wealth. This plan offers to partially withdraw the amount.

4. Money Back Policy

This policy is similar to endowment policy, the only difference is that this policy provides many survival benefits which are allotted proportionately over the period of the policy term.

5. Whole Life Policy

Unlike other policies which expire at the end of a specified period of time, this policy extends up to the whole life of the insured. This policy also provides the survival benefit to the insured.  In this type of policy, the policyholder has an option to partially withdraw the sum insured. Policyholder also has the option to borrow sum against the policy.

6. Annuity/ Pension Plan

Under this policy, the amount collected in the form of a premium is accumulated as assets and distributed to the policyholder in form of income by way of annuity or lump sum depending on the instruction of insured.

Principles of Life Insurance

Life insurance is based on a number of principles that are tailored to meet market conditions and ensure insurance companies make profits, while offering security policies to insured individuals.

There are broadly four major insurance principles applied in India, these being:

• Insurable Interest: This principle pertains to the level of interest an individual is expected to have in a particular policy. The interest could be a family bond, a personal relationship and so on. Based on the interest level, an insurance company can choose to accept or reject an application in order to protect the misuse of a policy.

• Law of large numbers: This is a theory that ensures long-term stability and minimises losses in the long run when experiments are done with large numbers.

• Good faith: Purchasing an insurance is entering into a contract between company and individual. This should be done in good faith by providing all relevant details with honesty. Covering any information from the insurance company may result in serious consequences for the individual in the future. This being said, the insurer must explain all aspects of a policy and ensure that there are no unexplained or hidden clauses and that the applicant is made aware of all terms and conditions.

• Risk & Minimal loss: Insurance is a risky and companies have to do business and make profits keeping in mind the risk factor. The principle of minimal risk states that the insured individual is expected to take necessary action to limit him/her self from any hazards. This includes following a healthy lifestyle, getting a regular health check-up and more.

Points to Consider for Life Insurance

• Research: As an applicant for life insurance, there are numerous policy options at your fingertips to choose from. It is essential that you do your research before making an informed decision on purchasing a life insurance policy, as it can help you save money and receive maximum benefits.

• Read terms and conditions: The terms and conditions of an insurance plan contain all relevant information regarding the particular policy. Make sure that you read the fine print in detail and completely understand it before purchasing an insurance policy of your choice.

• Remember lock-in period: There are instances when individuals purchase insurance policies without making an informed decision and later realise that they are unhappy with the insurance policy. In such scenarios, some insurance companies offer a lock-in time frame, which is a short time usually 15 days where a policyholder can return the policy to the insurer and purchase another in case they were unsatisfied with the initial purchase.

• Consider premium payment options: Almost all insurance providers offer premium payment options consisting of annual, semi-annual, quarterly or on monthly basis. It is essential that you opt for Electronic Check System (ECS) payment that will periodically debit your bank account with the required insurance amount. Also, you can choose from a schedule that will allow you to make a premium payment with the convenience of interval payments.

• Don’t Mask Information: There are times where individuals try to hide information when filling out the insurance application form. All personal credentials and medical history must be accurately presented to the insurance company. Misinformation can cause serious issues when trying to make claims later on.

Life Insurance Companies in India

Some of the prominent life insurance companies in India are:

1. LIC: Life insurance corporation of India
2. SBI Life Insurance
3. ICICI Prudential Life Insurance
4. HDFC Standard Life Insurance
5. Bajaj Allianz Life Insurance
6. Max Life Insurance
7. Birla Sun Life Insurance
8. Kotak Life Insurance