FINANCIAL MANAGEMENT

FINANCE
• Finance is the life blood of business.
• Finance is the provision of money at the time
when it is needed.
 Financial Management
• Financial Management = Management of funds

• Applying general management principles to financial resources

• Financial management is that activity of management which is

concerned with the planning, procuring and controlling of the
Applying general management principles to financial resources
firm's financial resources.

• Financial Management deals with procurement and effective

utilization of funds
 DEFINITION
• “Financial management is the activity concerned with
planning, raising, controlling and administering of funds
used in the business.” – Guthman and Dougal

• “Financial management is the operational activity of a

business that is responsible for obtaining and effectively
utilizing the funds necessary for efficient operations.”-
Massie
 NATURE OF FINANCIAL MANAGEMENT

• Financial management is pervasive throughout the organisation.

• Financial operations are centralized.

• Financial management involves with data analysis for use in

decision making.

• The central focus of financial management is valuation of the

firm. ie, financial decisions are directed at increasing the value of
the firm.
 NATURE OF FINANCIAL MANAGEMENT

• Financial management essentially involves risk-return trade-off

• Financial management affects the survival, growth and vitality of

the firm.

• Finance functions are performed in all firms - business or non-

business, big or small, proprietary or companies

 NATURE OF FINANCIAL MANAGEMENT

• Financial management is a sub-system of the business system

which has other subsystems like production, marketing, etc

• Financial Management is the activity concerned with the

control and planning of financial resources.

• Financial management is multi-disciplinary in approach.

 FINANCE AND OTHER RELATED DISCIPLINES

1. Finance and Economics

2. Finance and Accounting

3. Finance and Production Management

4. Finance and Marketing Management

5. Finance and Quantitative Methods

6. Finance and Costing

 FINANCE AND OTHER RELATED DISCIPLINES
7. Finance and Law

8. Finance and Taxation

9. Finance and Treasury Management

10. Finance and Banking

11. Finance and Insurance

12. International Finance

13. Finance and Information Technology

 OBJECTIVES OF FINANCIAL MANAGEMENT

Profit maximization
• It is commonly believed that a shareholders objective is to
maximise profit.

• To achieve the goal of profit maximisation, the financial

manager takes only those actions that are expected to make a
major contribution to the firm's overall profits
 PROFIT MAXIMIZATION

Points in favour of profit maximisation:

• It is a parameter to measure the performance of a business
• It ensures maximum welfare to the shareholders, employees
and prompt payment to the creditors
• Increase the confidence of management in expansion and
diversification.
• It indicates efficient use of funds for different requirements.
 PROFIT MAXIMIZATION

Points against profit maximisation:

• It is not a clear term like accounting profit, before tax or after

tax or net profit or gross profit.

• It encourage corrupt practices

• It does not consider the element of risk

• Time value of money is not reflected

 PROFIT MAXIMIZATION
Points against profit maximization:
• Attracts cut –throat competition

• Huge profits attracts government intervention

• It invites problem from workers.

• It affects the long run liquidity of a company.

 OBJECTIVES OF FINANCIAL MANAGEMENT

Wealth Maximization
• The goal of the finance function is to maximise the wealth of
the owners.

• The wealth of corporate owners is measured by the share

prices of the stock.

• While taking decisions, only those actions which is expected

to increase share price should be taken.
 WEALTH MAXIMIZATION
It considers :
(a) Time value of money on investment decision

(b) The risk or uncertainty of future earnings and

(c) effects of dividend policy on the market price of shares.

 WEALTH MAXIMIZATION

Points In favour of Wealth Maximization

• It is a clear term
• It considers the time value for money.
• It should be accepted universally
• It guides the management in framing a consistent strong
dividend policy to reach maximum return to the equity share
holders
• . l.
 WEALTH MAXIMIZATION

Points against wealth maximization:

• This concept is useful for equity share holders not for
debenture holders
• The expectations of workers, consumers and various interest
groups create a greater influence that must be respected to
achieve long run wealth maximization and also for their
survival.
PROFIT VS WEALTH MAXIMIZATION
Basis Wealth Maximization Profit Maximization

It is defined as the
It is defined as the management
management of financial
of financial resources aimed at
Definition resources aimed at
increasing the profit of the
increasing the value of the
company.
stakeholders of the company.

Focuses on increasing the

Focuses on increasing the profit
value of the stakeholders of
Focus of the company in the short
the company in the long
term.
term.
Basis Wealth Maximization Profit Maximization

It considers the risks and

It does not consider the risks
uncertainty inherent in the
Risk and uncertainty inherent in the
business model of the
business model of the company.
company.

It helps in achieving a larger

It helps in achieving efficiency in
value of a company’s worth
the company’s day-to-day
Usage which may reflect in the
operations to make the business
increased market share of
profitable.
the company.
SCOPE OF FINANCIAL MANAGEMENT
 TRADITIONAL APPROACH

1920s and 1930s

According to this approach, the scope, of finance function was

confined to only procurement of funds

The utilisation of funds was considered beyond the purview of

finance function
 LIMITATIONS OF TRADITIONAL APPROACH

• The issue of allocation of funds, which is so important today,

is completely ignored.

• The focus of traditional approach was on procurement of

long-term funds. Thus, it ignored the important issue of
working capital finance and management.
 MODERN APPROACH

• Includes both rising as well as effective utilisation of funds

• Finance functions, according to this approach, covers financial

planning, rising of funds, allocation of funds, financial control

• The modern approach considers the three basic management

decisions, i.e., investment decisions, financing decisions and
dividend decisions within the scope of finance function.
FINANCIAL DECISIONS
FINANCIAL DECISIONS
 INVESTMENT DECISIONS
Investment decisions are the financial decisions taken by
management to invest funds in different assets with an aim to
earn the highest possible returns for the investors.
It involves evaluating various possible investment opportunities
and selecting the best options. The investment decisions can be
long term or short term.
.
LONG-TERM INVESTMENT DECISIONS OR CAPITAL BUDGETING
• Committing funds for a long period of
time like fixed assets.
• Irreversible and usually include the
ones pertaining to investing in a
building and/or land, acquiring new
plants/machinery or replacing the old
ones, etc.
• These decisions determine the
financial pursuits and performance of
a business..
 WORKING CAPITAL DECISIONS
.
• Short-term investment
decisions or Working Capital
Management means
committing funds for a short
period of time like current
assets.
• These involve decisions
pertaining to the investment of
funds in the inventory, cash,
bank deposits, and other short-
term investments.
 FINANCING DECISIONS
.
• Financing decisions are the financial decisions related to raising of finance.
• It involves identification of various sources of finance and the quantum of
finance to be raised from long-term and short-term sources.
• A firm can raise long term finance either through shareholders’ funds or
borrowed capital.
• The financial management as part of financing decision, calculates the
cost of capital and the financial risks for various options and then decides
the proportion in which the funds will be raised from shareholders’ funds
and borrowed funds.
 FINANCIAL PLANNING DECISIONS
.
• Financial Planning decisions
relates to estimating the
sources and application of
funds.
• It means pre-estimating
financial needs of an
organization to ensure the
availability of adequate
finance.
 CAPITAL STRUCTURE DECISIONS
.
• Capital Structure decisions which
involve identifying sources of funds.
• They also involve decisions with respect
to choosing external sources like issuing
shares, bonds, borrowing from banks or
internal sources like retained earnings
for raising funds.
• The decisions are made in the light of
the cost of capital, risk factor involved
and returns to the shareholders.
 DIVIDEND DECISIONS
.
• Dividend decision is to whether to distribute earnings to
shareholder as dividends or retain earnings to finance long-
term profits of the firm

• Dividend is that portion of divisible profits that is distributed to

the owners i.e. the shareholders.

• Retained earnings is the proportion of profits kept in, that is,

reinvested in the business for the business.
 DIVIDEND DECISIONS
.
Shareholders always demand a
higher dividend, while the
management would want to retain
profits for business needs. It must
be done keeping in mind the firms
overall objective of maximizing the
shareholders wealth.
 ORGANIZATION OF FINANCE FUNCTION
• . Finance Committee’ to review and formulate financial policies.
• Two more officers, namely ‘treasurer’ and ‘controller’ – may be appointed
under the direct supervision of CFO to assist him/her.
• The function of the treasurer of an organization is to raise funds and
manage funds. It includes forecasting the financial requirements,
administering the flow of cash, managing credit, flotation of securities,
maintaining relations with financial institutions
• The controller’s functions include providing information to formulate
accounting and costing policies, preparation of financial reports, direction
of internal auditing, budgeting, inventory control payment of taxes, etc.
.
 ROLE OF FINANCIAL MANAGER
1.. Determining financial needs
2. Determining sources of funds
3. Financial analysis
4. Optimal capital structure
5. Cost - volume profit analysis
6. Profit planning and control
7. Fixed assets management
8. Capital budgeting
9. Dividend policies
10. Acquisition and mergers
 SOURCES OF FINANCE
. LONG TERM SOURCES
LONG TERM SOURCES INTERNAL SOURCES
EXTERNAL SOURCES 1. Retained earnings
1.Owned capital (Preference and 2.Provision for Depreciation
Equity Capital)
2. Debentures
3. Public Deposits
4. Lease Financing
5. Hire Purchase SHORT TERM SOURCES
6. Institutional Assistance 1. Loans from Banks
7. Government subsidies 2. Public Deposits
8. Mortgage Bonds 3. Trade Credit
9. Venture Capital 4. Discounting Bills of Exchange
5. Factoring
6. Bank Overdraft
7. Cash Credit
8. Advances from Customers
9. Accrual Accounts
 TIME VALUE OF MONEY
The
. term ‘Time Value of Money (TVM)’ implies that there is a
connection between ‘time’ and ‘value of money’. This concept
can be explained by a simple question – Would you prefer to
receive Rs1000 today or after a year? The answer shall always be
obviously ‘today’. Let us understand why we prefer it today.
 TIME VALUE OF MONEY
If .you receive Rs1000 now, you can deposit it in a bank at say 10%
interest rate, a value of your money after a year will be Rs1100.

On the other hand, if you opt to receive money after a year, you will
get Rs100. The first option is preferred because, after one year, you are
better off byRs100.

In the current example, the future value of Rs100 is Rs110 or the

present value of Rs1100 is Rs1000 and Rs100 is the time value of
money for 1 year.
 TIME VALUE OF MONEY
The
. idea that money available at the present time is worth
more than the same amount in the future due to its potential
earning capacity is called the time value of money
 TIME VALUE OF MONEY
• . A Rupee is always worth more today than it would be worth
tomorrow, according to the concept of the time value of money

• Discounting is the process of determining the present value of a

future payment or stream of payments.

• The present value formula shows you how much once single cash
payment received in a future time period is worth in today’s terms.

• The present value of a sum is the current value of the amount that
would be received in the future
 TIME VALUE OF MONEY
Reasons
. why money can be more valuable today than in the
future
• Preference for Present Consumption:
• Inflation
• Risk
 RISK AND RETURNS
• . Risk : Risk is defined as the chance that an outcome or
investment's actual returns will differ from an expected return

• Return: It can be defined as the actual income from a project

as well as appreciation in the value of capital

• Return = Cash payments received + Price change in assets

over the period /Purchase price of the asset.
 RISK AND RETURNS
• . The risk-return tradeoff is an investment principle that
indicates that the higher the risk, the higher the potential
reward.
 RISK AND RETURNS
.