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Management of business organizations

managements

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MANAGEMENT OF BUSINESS ORGANIZATIONS



          Objectives:

                        -           supply information and legal terminology

-       firm documents, management terminology and concepts

-       different departments in a firm

1.1. Legal personality

            In any legal system individuals or companies may be regarded as having rights and duties enforceable at law. A company can sue a partner for breach of a contract in virtue of its legal personality. Without it institutions and groups cannot operate, for they need to be able maintain and enforce claims. Individuals, limited companies and public corporations are recognized as possessing a distinct legal personality, the terms of which are circumscribed by the relevant legislation. It is the law which is the foundation of legal personality for it will determine the scope and nature of personality. Legal personality involves concepts such as status, capacity, competence as well as the nature and extent of particular rights and duties. The whole process operates within the confines of relevant legal system which circumscribes personality, its nature and definition. Legal personality is crucial. Without it institutions and groups cannot operate, for they need to be able to maintain and enforce claims. Individuals, limited companies and public corporations are recognized as each possessing a distinct legal personality, the terms of which are circumscribed by the relevant legislation. It is the law which is the foundation of legal personality for it will determine the scope and nature of personality. The status of a particular entity may well be determinative of certain powers and obligations, while capacities will link together the status of a person with particular rights and duties. This is particularly true in international law. In international law, personality needs consideration of the inter-relationship between rights and duties afforded under the international system and capacity to enforce claims. One of the distinguishing characteristics of contemporary international law has been the wide range of participants performing on the international scene. These include states, international organizations, regional organizations, non-governmental organizations, public companies, private companies and individuals.

            Public companies, which may be known by a variety of names, for example, multinational public enterprises or international bodies corporate, is characterized in general by an international agreement for cooperation between governmental and private enterprises. Such enterprises may vary widely in constitutional nature and in competences.

            They can have an intergovernmental structure and operate in a global commercial activity. The personality question will depend upon the differences between municipal and international personality. If the entity is given a range of powers and is distanced sufficiently from the municipal law, an international person may be involved, but it will require careful consideration of the circumstances.

            Transnational or multinational enterprises are also subject of international legal personality. They constitute private business organizations comprising several legal entities linked together by parent corporations and are distinguished by size and multinational spread.

            There are different legal forms in which entrepreneurship may be organized according to the size of the firm and according to the way of raising capital.

            For working or short-term capital a firm can find help in a variety of ways, most usually through the commercial banks, but also by hiring buildings and sometimes machinery, buying factors, obtaining the customary trade credit terms and taking deposits in advance from customers.

            The sole-proprietor or one-man firm is the oldest form of entrepreneurial organization. Such one-man firms range from the rag and bone man, chimney-sweeper and window-cleaner working on his own account to the farmer, shopkeeper and small factory-owner who employs other workers and may even own many separate units. Nevertheless, these businesses all have the same characteristic of being owned and controlled by a single person. It is the person's task to make all decisions regarding the policy of the firm and it is he alone who takes the profit and bears any losses made. This makes for energy, efficiency, a careful attention to detail and close relationship between employer and employee.

            The sole proprietor, however, suffers from the main disadvantage. First, the development of such a firm must proceed slowly because the sources of capital are limited. The success of the venture, especially in its early stages, depends on the person in charge, and nobody is likely to provide capital for the business unless he has that confidence in the proprietor, which comes from personal contact. Hence, the main source of capital is the personal savings of the owner himself, together with such additional sums, as he may be able to borrow from the relatives or close friends. Expansion of the business may take place by ploughing back profits, but this will probably be an extremely slow process and such firms generally remain comparatively small.

            In the event of failure, not only the assets of the business, but also the private assets of the proprietor can be claimed against creditors, meaning that there is no limited liability. It is typical for agriculture and retailing where management requirements make the small technical unit desirable.

            A larger amount of capital is available when persons combine in a partnership. Each partner provides a part of the capital required and shares the profit on an agreed basis. Yet, the amount of capital that can be raised this way is still inadequate for large-scale production. The result is that the partnership remains relatively small, particularly suitable to certain types of business, such as retailing, and certain professions (doctors, dentists, consulting engineers and lawyers). The risk inherent in unlimited liability is increased because all partners are liable for the firm's operations, irrespective of the amount of capital that they have individually invested, and their private fortunes may be called upon to meet the demands of creditors. Any action taken by one colleague is legally binding on the others. Hence not only must each partner have complete confidence in the others, but the risk of unlimited liability increases. Finally, by giving notice to the others, one partner may terminate the partnership at any time, while it is automatically dissolved upon the death or bankruptcy of any one partner. This means that surviving partners have to either buy his share or find a purchaser

acceptable to everyone. In such circumstances, therefore, the continuation of the

business may involve great trouble and expense.

            In Great Britain, the joint stock company type first developed in Tudor times when foreign trade began to expand. The government, wishing to foster such trade, often granted the promoters a charter, which enabled them to form a company and to carry on trade in various parts of the world, usually in a free form of competition. Two such companies were the East India Company and the Hudson's Bay Company, still existing today.

            Nevertheless, until the middle of the nineteenth century, people were reluctant to take shares in such companies, as they enjoyed no limited liabilities. But the industrial revolution made it essential that more capital should be available to industry. Hence, in order to induce more savers to invest, the privilege of limited liability was granted by statute in 1855.

            The advantages that the most important form of a business organization enjoys over the partnership are chiefly that there is limited liability, a larger amount of capital can be raised, since investors can spread their risk and sell their shares easily, and, should the need arise, expansion is much easier.

            Against the advantages, however, certain disadvantages have to be considered. The company's corporation tax could be more than the income tax that would have been paid had the business remained as a sole partnership. Furthermore, any assets of the company that have been built up over the years will increase the value of the original shares (usually owned by a family). When the time comes to wind up the company, e.g. owing to retirement, any increase in the value of the shares will be subject to capital gains tax.

1.1.1. Private Company

            This type of a company organization allows the business to be privately owned and managed. It is thus particularly suitable for a medium-sized either commercial or industrial organization not requiring finance from the public or for a speculative venture where a small group of people wishes to try out an idea and is prepared to back it financially to a definite limit before floating a public company.

            While they are considerably more numerous than public companies, they are much smaller. They encounter difficulties when they want to expand as neither their shares nor debentures can be offered for sale to the public. Thus, in order to find additional investors, it is usually necessary to convert the business into a public company with its shares quoted on a Stock Exchange. But before embarking on such an issue, the company must have a fairly substantial size and arrange for a life insurance company or an investment trust to purchase shares or debentures; help may be obtained from the new-issue market, where both issuing houses and merchant banks may help firms to raise capital. But in order to obtain a loan, it has to pass first a searching investigation regarding its present financial position and business prospects.

1.1.2. Public Limited Company

            It carries the letters PLC after its name is the largest of all types, and at least two shareholders own it, but most of them have hundreds or even thousands of shareholders.

            Its shares can be issued to the public and can be sold through the Stock Exchange. A private company can 'go public' and apply to the Stock Exchange to be listed or quoted in order to become a public limited company. The company will have to satisfy the council of the Stock Exchange that is soundly based and a

reasonable investment for the public.

            It is controlled by the Board of Directors, which is elected by the

shareholders. The Board manages the running of the firm that is obliged to hold an Annual General Meeting to report to shareholders and elect directors.

            The company uses its profits (after deduction of dividends) to finance future investments. Capital may also be obtained by further share issues, borrowing (often from international banking consortia) and from Government granting loans.

1.1.3. Holding



            The optimum technical unit of a business may be much smaller than the optimum financial unit. The financial economies of scale can be achieved by organizing a group of firms through a single 'holding company', leaving the individual subsidiaries to continue working in their own name as separate technical units and retaining a great deal of independence of action. Furthermore, having subsidiaries with diverse interests may secure a risk-bearing economy.

            However, while this theoretical justification for the formation of a holding company may be valid, in practice such companies have been formed in order to obtain controlling interests, often for monopoly purposes.

1.1.4. Joint Stock Company

            This type of a company is organized on the agreement of two or more parties to work on a project together. Frequently, it is formed when companies with complementary technology wish to create a product or service that takes advantage of the strengths of the participants. It is usually limited to a project, differs from a partnership, which forms the basis for cooperation on many projects.

1.2. Setting a company

            Setting up of a company begins with lodging a Memorandum of Association and the Charter of the company or Articles of Association with the Registrar of Companies.

            The Memorandum generally contains the following clauses stating:

- the name of the company and its logo; the company is free to choose its name, within certain bounds. The Department of Trade will not allow a name which is too similar to that used by an existing company, especially one in the same type of business.

- the country in which the registered office (where the premises is situated)

- limitation clause: it shows whether the company is limited by shares or by guarantee, as commercial companies are limited by shares, or non-profit bodies, such as professional associations, are limited by guarantee.

- the objects for which the company was constituted; this states the type of

business that the company will undertake. This is to protect investors from putting their money into a company which would then use it in a different manner.

- capital clause: it gives details about the amount of the authorized capital and its division into shares and the different categories of shares

-association clause: includes the names of the founder members and the number of shares they each subscribed

            Lodged together with the Memorandum, The Articles of Association are a contract between the company and its members comprising rules and regulations for the internal activity of the company and specifying such things as :

- the voting power of its members,-

- the appointment of directors,-

- the distribution of the profits, etc.

            After the Memorandum and the Articles have been registered and the necessary fees have been paid, the Registrar issues the Certificate of Incorporation and the company can start doing business.

            Here are the Governmental institutions that a company should be registered with:

Notary Office

The Court of Commerce

The Registrar of Commerce

Tax/Fiscal Office

The Gazette

1.2.1. Structure of a business

            In a small business, the few employees know their role as there is a direct contact between the employer and the staff. As the business grows larger, the need for formal written structure tends to emerge. The organizational chart is drawn showing people in authority and those under their supervision. Here you have an illustration of a company framework:


           

Financial decisions are crucial. The secret of success in financial management is to increase value. The problem is how to do it. The financial

manager has two broad responsibilities: What investment should the firm make? How should it pay those investments? The first involves spending money; the second involves raising it.

            Companies need an almost endless variety of real assets: tangible (machinery, factories, offices): intangible, (technical expertise, trade marks, patents). To obtain the necessary money, the company sells financial assets or securities. Their value consists in their claim on the firm's real assets and the cash they produce. If the company borrows money from the bank, the bank has a financial asset that gives it a claim to a stream of interest payments and to repayment of the loan. The company's real assets need to produce enough cash to satisfy these claims. Financial assets include not only bank loans, but also shares of stock, bonds, lease financing obligations, and so on.

            The financial manager stands between the firm's operations and the financial markets, referred at as sources where the investors hold the financial assets issued by firms. He traces the flow of cash from investors to their firm and back to investors again. The flow starts when securities are issued to raise cash to purchase real assets to generate cash inflows later, to repay the initial investment. The cash is then either reinvested or returned to the investors who purchased the original security issue.

            The shareholders are made better off by any financing decision of the financial management that increases the value of their stake in the firm. A good capital budgeting decision is one that results in the purchase of a real asset that

makes a net contribution to value.

            Financial decisions cannot be separated from financial markets either. The financial manager must know whether the value of the firm would increase through an issue of shares to stockholders. He must have considered the interest rate on the loan and concluded that it was not too high. He must also cope with time and uncertainty. The investment, if undertaken, may have to be financed by debt that cannot be fully repaid for many years. The financial manager has to decide whether the opportunity is worth more than its costs and whether the debt burden can be safely borne.

            The financial manager is anyone responsible for a significant corporate investment or financing decision. But usually responsibility is spread out throughout the firm. The engineer who designs a new production facility, the marketing manager who commits to a major advertising campaign, but also the top manager is, of course, continuously involved in financial decisions.

            Nevertheless, there are managers specialized in finance: the treasurer - the most directly responsible for obtaining financing, managing the firm's cash accounts and its relationship with banks and often financial institutions in the financial market, and making sure the firm meets its obligations to the investors holding its securities.




            Larger companies usually have a controller who checks that the money is used efficiently. He manages budgeting, accounting, auditing. There can be a chief financial officer appointed to oversee both the treasurer' and the controller's work. He is involved in financial policy making and corporate planning but he also can have managerial responsibilities beyond strictly financial issues and may also be a member of the Board of Directors.

            But the ultimate decision often rests by law or by custom with the Board of Directors. Only the Board has the legal power to declare a dividend or to sanction a public issue of securities. Boards usually delegate decision-making authority for

small or medium sized investment outlays, but the authority to approve large investment is almost never delegated.


1.2.2. The role of commodity exchange

            A commodity exchange is the market where commodities are traded. The main terminal markets in commodities of the world are in London and New York, but in some commodities there are markets in the country of origin. Some commodities are dealt with at auctions (e.g. tea, grains) each lot being sold having been examined by dealers, but most dealers deal with goods that have been classified according to established quality standards. In these commodities both actuals and futures contracts are traded on commodities exchanges, often with daily callovers, in which dealers are represented by commodity brokers. Many commodity exchanges offer option dealing in futures, and settlement of differences on futures through a clearing house. As commodity prices fluctuate widely, commodity exchanges provide users and producers with hedging facilities with outside speculators and investors helping to make an active market, although amateurs are advised not to gamble on commodity exchanges.

            The fluctuations in commodity prices have caused considerable problems in developing countries, from which many commodities originate, as they are often important sources of foreign currency, upon which the economic welfare of the country depends. Various measures have been used to restrict price fluctuations but none have been completely successful.

1.2.2. Stocks

            Shares are products that enable their holders to participate in the company's activities and benefit from its success or failure. The conditions for ownership of shares can differ according to the rights they give the shareholders. The risk involved in buying shares is linked to how the company is expected to behave and, in particular, what its net profits are expected to be.

            Indicators have been created to relate predictions of the company's behavior - the market price, by which we can assess the market's appraisal of the company.

            Shares are securities representing a public limited company's share capital.

            Each share represents a part of the company in the hands of the shareholders. All shares represent equal parts into which the company's capital is divided. All shares have the same par value. Shares are not divisible, though they can be issued in blocks of number of shares (5, 10, 50, 100, etc).

            When a company is formed, i.e. when the Articles of Association and the Memorandum of Association are drawn up, they define the classes of share that can be issued.

            The different classes of shares differ with regard to the rights they confer on their holder. The main class in the generic type of share is the one of ordinary shares.

            Ordinary shares (normally referred to as just 'shares') confer the right to call a shareholders' meeting; to vote at the meetings, to elect and to be elected to the company's bodies. The company's Articles of Association may, however, establish the number of preferred shares a shareholder must have to be entitled to vote. He receives new shares in the event of capitalization of reserves and they are preferred in subscribing new shares when they are issued to raise capital or in subscribing convertible bonds. Each shareholder is entitled to subscribe the same number of shares as he already holds. However, the shareholders' meeting that decides on the issue may limit or suppress this right to preference. He is also free to transfer shares or to sell his shares at will. This right is one of the ways of obtaining a return of the investment, i.e. a gain from the favorable difference between the selling and buying price.

            The dividend is the return on shares. It represents a part of the distributable profit that is paid on each share. This return is variable as it depends on whether there are profits in each financial year and on whether the Annual General Meeting agrees to their distribution (as proposed by the Board of

Directors).

            A company's dividend policy is represented by the percentage of the profits generated by the company in a particular financial year that it decides to

distribute to the shareholders.

            The dividend is important because it represents a source of income for the investor and it is an important indicator to current or potential investors of the company's future profitability. It gives information on the company's projected growth, thus influencing share prices.

            The validity of ordinary shares is indefinite, i.e. it is not established in advance. The shares exist as long as the company that issues them exists. The secondary market is the only way shareholders have of getting back the capital they invested, as they cannot demand a refund of their investment. This is the main reason why shares are quoted on the stock exchange.

1.2.3. Bonds                         

            Historically, bonds are institutionalized borrowings by governments or business, with the date of repayment, and the annual rate of interest to be paid meanwhile, fixed at the time of issue. There are irredeemable government and corporate bonds, where the interest rate is fixed but no date for repayment. There are floating rate bonds, where the interest rate paid is related to the changing rate in the market. There are also zero coupon bonds which pay no interest at all but which are issued at a price very much lower than the repayment due on a particular date, so that income effectively takes the form of capital gains. There are index-linked bonds, which pay a small or no rate of interest but whose repayment, at some fixed date, includes compensation for the interim rise in the cost of living. There are convertible bonds, which carry the

right of conversion into corporate equities.

            The new economy based on the Internet should be called the 'nude economy' because the Internet makes it more transparent and exposed. The Internet makes it easier for buyers and sellers to compare prices. It cuts out the middleman between firms and customers and it reduces transactions costs. That's why more than 25% of American share market now take place via Internet. Yet the e-bond market hasn't reached such an extent. The potential for electronic bonds trading seems to be less than in on-line futures and options. A reason for this might be that individual investors aren't as interested in bonds as they are on shares, because unlike some share prices, bond prices rarely double in 12 months. Moreover, bonds are much less liquid than shares. Investors, such as insurance companies that hold them to maturity, often buy them. However, these things can change. There is a serious talk that the bond market may soon become as automated and real as that for equities. This change is possible because of the innovation that will soon activate the 1st 'Bond Connect' trading system. This will allow the institutional investors that dominate the bond equity to trade directly with each other through a sophisticated order-matching system operated under the auspices of a Stock Exchange. The institution will be able to put large black trade orders into the system safe in the knowledge that no information about their intention will leak into the market before the order has been executed. This should allow them to get a much better price.

            Many recent issues of e-bonds allow brokers to trade more efficiently with each other but do not provide access to their customers. Electronic trading has the potential greatly to enhance the efficiency on the bond market.

1.3. Money Matter, Banking and Financial Markets

            For thousands of years, gold was the ultimate money. It could buy anything including hearts. It was wealth and power to be sure, but it was also enchantment, with a special luster and reassuring weight and feel. The lure of gold drove ships across stormy seas and explorers across rugged mountains to places as remote as Canada's Klondike region near the Arctic Circle.

            Gold isn't used as money any more. It still glitters, but it's treated more like soybeans or pork bellies than a ransom fit for a king.

            Money didn't exist in ancient times, so people had to trade with each other - or barter - to obtain the items they wanted. The first trades were probably animal skins for grain, or cotton for livestock.

            But these exchanges were cumbersome, and some common commodities, such as grains, started to assume the role of money. In early Egypt, for example, barley, an important source of food, became the accepted means of payment for goods and services.

            By 700 B.C., though, the Egyptians had abandoned barley and adopted gold as their primary instrument of exchange. A rare and beautiful metal, gold had become the universal symbol of wealth and power. And, being portable and durable, it was an ideal form of money.

            By the 15th century trade and commerce had expanded tremendously. When King Croesus of ancient Lydia (now Western Turkey) had gained control of Asia's richest gold mines for the Persian Empire, he wanted others to recognize his newfound power and ordered the first gold coin to be made. Bearing the image of a lion and a bull, the coin became the standard of exchange for all trade and commerce.



            A need appeared for a new, less cumbersome system of making payments. The goldsmiths met this need. Their system worked this way: people would deposit their gold coins at their local goldsmith's. In return, the goldsmiths would give them a receipt. Eventually, the receipt began to circulate as money because they could always be redeemed for the gold itself.

            Gradually, countries came to adopt a form of the goldsmith's system. Their governments printed currency and backed it up with gold they held in official reserves. And so the 'gold standard' for currencies was born. One of the first countries to adopt the gold standard was Great Britain in 1916. It made its currency the pound, equal in value to an ounce of gold. Then Coinage Act of 1792 first put the young American nation on a 'bimetallic standard', backing the dollar, which was a coin at the time, with both gold and silver.

            With the world at war, for the first time, people were seeking security, and thus started exchanging their currency for gold. But governments soon saw their reserves run seriously low, as a result. By 1914 most countries, except the United States, abandoned the gold standard to protect their reserves.

            By the mid 1930's, practically all the major nations had abandoned the gold exchange standard. Governments would accumulate dollars that they could redeem for gold at the U.S. Treasury.

            Of course, gold will always be the metal of choice for the jet-set, who like to adorn their homes with gold-leaf sinks, bathrooms and picture frames.

            Today, gold can be bought and sold in several different forms: coins, bullion or perhaps just as paper claim to the metal.

            There are two types of gold coins: bullion coins and numismatic. Countries produce the bullion coins as legal tender, which means they can be spent as money. Prices are based on the local gold price in London (The 'London Fix').

            Numismatic gold coins no longer circulate as money. Their value derives more from their condition and rarity than their actual gold content.

            Many investors hold paper claims to gold in the form of future contracts. These contracts are nothing more than a commitment to buy or sell gold at a future time at a pre-agreed price. Typically, the buyer and seller meet at a commodity exchange to work out future contracts.

            Today gold has assumed the role of a commodity such as wheat or cotton. And like any other commodity, its price is determined in a free market by the forces of supply and demand.

            What will make money what it is? Partly we will determine it by statutes declaring that certain pieces of paper and metal produced by government will be money. These notes and coins we call will be 'legal tender' and you'll have to accept them as payment in full for any transaction.

            However, part of what we regard as money will be determined by custom. If you think about how much money (as distinct from wealth) you have, you won't consider only your holdings or cash and coin - you'll include deposits you have in your bank.

            Whether it's cash or bank deposits, money is an asset for you and simultaneously a debt for either the bank or the government. That's why credit cards will be not considered money, but tangible proof that you've been granted a line of credit (a loan up to a predetermined amount which you can decide to activate). Because they represent a debt for, not an asset they will never be money.

            Since January 1st, 1999 the euro has been operating as a recognized currency on the world markets and has been widely used, especially by commercial banks and other companies, in non-cash payment transactions. On January 2002 the euro banknotes and coin will be put into circulation. Their design and production was, from the outset, planned as a cooperative venture of the European Union. The graphic symbol of the euro was inspired by the Greek letter epsilon and refers to the first letter of the word Europe. The parallel lines represent the stability of the euro. The official abbreviation for the euro has been

registered with the International Organization for Standardization ISO.

            The euro banknotes depict the architectural styles of seven periods in European cultural history Classical, Romanesque, Gothic, Renaissance, Baroque and Rococo, the age of iron and glass architecture, and the modern 20th century architecture and emphasize three main architectural elements - windows, gateways, and bridges. The windows and gateways on the front of each banknote symbolize the spirit of openness and cooperation in Europe. The 12 stars of the European Union are also featured, representing the dynamism and harmony of the contemporary Europe. The reverse of each banknote features a bridge typical of the respective age of European cultural development. These bridges range from early constructions to the sophisticated suspension bridges on the modern era and are used as a metaphor for communication among the people of Europe as well as between Europe and the rest of the world.

            The European System of Central Banks became operational and is responsible for framing and implementing the single monetary and exchange rate policy (setting short-term interest rates in euro). The participating national currencies will no longer be listed on the foreign exchange markets.

            As far as banks and large firms are concerned, the transition to the single currency began chiefly via the single monetary and exchange rate policy, the capital and the associated settlement systems. Banks draw up their customers' account statements in both euro and national currency. They take advantage of the time available in order to inform their customers of the consequences of the switch to the single currency for their financial transactions. They step up their staff training efforts to prepare for the changeover and can also offer certain products in euro, legal and technical constraints permitting.

            Consumers continue to use chiefly their own national currency because euro banknotes and coins are not yet available. Public demand can, however, swiftly prompt some banks or firms to offer services in euro.

            The gradual introduction of dual pricing of goods and services enables consumers to get used to the single currency. By developing a 'feel' for prices in the single currency and learning to convert national currencies into euro at a fixed rate, they thus realize that they do not stand to lose from the introduction of the single currency.

1. He explains that the balance sheet will be the main document showing the estate of our business.

2. He says that the new service will enable customers to make payments from their accounts by credit transfer.

3. He learns that the process of globalization that enables investment in financial markets will be carried out on an international basis.

4. They are sure that the goodwill of their company will become a saleable asset.

5. He declares that he will calculate again his gross income.

6. The shop assistant assures us that he will bring any items made of gold, silver or platinum, stamped with hallmark.

7 The general manager promises to keep a house journal for all the employees to inform them about the policy of the company.

8. He explained that the wages of the employees would reflect partly a return of the human capital for the future.

9. The wholesaler pretends that he will be allowed goods according to the import license.

10. The politicians pretend that indexation policy will mitigate the effects of inflation.

1.3.1. Functions of money

            The use of money as a medium of exchange makes possible a great extension of the principle of specialization. In an advanced society the use of money allows to exchange hours of labor for an amazing variety of goods and services: two weeks' labor for a holiday abroad just as easily as we can exchange it for a piece of furniture or a year's rent on a flat. Such exchanges are taken for granted yet they would be inconceivable without the use of money.

            The first step in the use of money was probably the adoption of some commodity as a unit of account or measure of value. Money, most likely, came into use within the barter system as a means whereby the values of different goods could be compared. The direct exchange of goods for goods raise all sorts of problems regarding valuation: 'How many bushels of corn are equal in volume to one sheep, if twenty sheep exchange for three cows and one cow exchanges for ten bushels of corn? This problem of exchange rates is easily solved when all other commodities are valued in terms of a single commodity which then acts as a standard of value. Money now serves as such a standard and when all economic goods are given money values (i.e. prices), we know immediately, the value of one commodity in terms of any other commodity.

            Once a commodity becomes universally acceptable, in exchange for goods and services, it is possible to store wealth by holding stock of this commodity. It is a great convenience to hold wealth in the form of money.

            Consider the problems of holding wealth in the form of some other commodity, say wheat. It may deteriorate, it is costly to store, it must be insured, and there will be significant handling costs in accumulating and distributing it. In addition, its money value may fall while it is being stored. The form of money has become very apparent in recent years - during periods of inflation when the exchange value falls.

            An important function of money in the modern world, where so much business is concluded on the basis of credit, is to serve as a means of deferred payment. When goods are supplied on credit, the buyer has immediate use of the goods, but she does not have to make an immediate payment. He can pay for them, 3, or perhaps 6 months after delivery. In the case of hire purchase contracts, the buyer takes immediate delivery but pays by means of installments spread over 1, 2, or 3 years.

            A complex trading organization based on a system of credit can only operate in a monetary economy. A seller would be most unlikely to accept any promise to pay in the future that was expressed in terms of a commodity other than money. It will have no idea how much of that commodity it will need in the future and if it does not want it, it will be faced with the trouble and risks involved in selling it. It is prepared to accept promises to pay in terms of money, because, whatever the patterns of the future be, they can be satisfied if it has money.

1.3.2. Banking

            Commercial banks borrow money from the public, crediting them with deposits of money. The deposit is a liability of the bank that is money owned to depositors. In turn, banks lend money to firms, households or governments wishing to borrow.








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