Financial

Management
V Sem B. Com (NEP – Batch 2)
 Unit 1: Introduction to Financial Management
Meaning of Financial Management

Financial Management means planning, organizing, directing and controlling the financial
activities such as procurement and utilization of funds of the enterprise. It means applying
general management principles to financial resources of the enterprise.

Scope/Elements

1. Investment decisions includes investment in fixed assets (called as capital budgeting).

Investment in current assets are also a part of investment decisions called as working
capital decisions.
2. Financial decisions - They relate to the raising of finance from various resources which
will depend upon decision on type of source, period of financing, cost of financing and
the returns thereby.
3. Dividend decision - The finance manager has to take decision with regards to the net
profit distribution. Net profits are generally divided into two:
a. Dividend for shareholders- Dividend and the rate of it has to be decided.
b. Retained profits- Amount of retained profits has to be finalized which will
depend upon expansion and diversification plans of the enterprise.

Objectives of Financial Management

The financial management is generally concerned with procurement, allocation and control of
financial resources of a concern. The objectives can be-

1. To ensure regular and adequate supply of funds to the concern.

2. To ensure adequate returns to the shareholders which will depend upon the earning
capacity, market price of the share, expectations of the shareholders.
3. To ensure optimum funds utilization. Once the funds are procured, they should be
utilized in maximum possible way at least cost.
4. To ensure safety on investment, i. e, funds should be invested in safe ventures so that
adequate rate of return can be achieved.
5. To plan a sound capital structure-There should be sound and fair composition of capital
so that a balance is maintained between debt and equity capital.

Functions of Financial Management

1. Estimation of capital requirements: A finance manager has to make estimation with

regards to capital requirements of the company. This will depend upon expected costs
and profits and future programmes and policies of a concern. Estimations have to be
made in an adequate manner which increases earning capacity of enterprise.
2. Determination of capital composition: Once the estimation has been made, the capital
structure has to be decided. This involves short- term and long- term debt equity
analysis. This will depend upon the proportion of equity capital a company is
possessing and additional funds which have to be raised from outside parties.
 3. Choice of sources of funds: For additional funds to be procured, a company has many
choices like-
a. Issue of shares and debentures,
b. Loans to be taken from banks and financial institutions
c. Public deposits to be drawn like in form of bonds.
d. Choice of factor will depend on relative merits and demerits of each source and
period of financing.
4. Investment of funds: The finance manager has to decide to allocate funds into profitable
ventures so that there is safety on investment and regular returns is possible.
5. Disposal of surplus: The net profits decision has to be made by the finance manager.
This can be done in two ways:
a. Dividend declaration - It includes identifying the rate of dividends and other
benefits like bonus.
b. Retained profits - The volume has to be decided which will depend upon
expansion, innovation, diversification plans of the company.
6. Management of cash: Finance manager has to make decisions with regards to cash
management. Cash is required for many purposes like payment of wages and salaries,
payment of electricity and water bills, payment to creditors, meeting current liabilities,
maintenance of enough stock, purchase of raw materials, etc.
7. Financial controls: The finance manager has not only to plan, procure and utilize the
funds but he also has to exercise control over finances. This can be done through many
techniques like ratio analysis, financial forecasting, cost and profit control, etc.

Aims of Financial Management:

The aims of financial management should be useful to the firm’s proprietors, managers,
employees and consumers. For this purpose, the only way is maximisation of firm’s value.

The following aspects have place in maximising firm’s value:

1. Rise in profits: If the firm wants to maximise its value, it should’ increase its profits
and revenues. For this purpose, increase of sales volume or other activities can be taken
up. It is the general feature of any firm to increase profits by proper utilisation of all
opportunities and plans. Theoretically, firm gets maximum profits if it is under
equilibrium. At that stage the average cost is minimal and the marginal cost and the
marginal revenues are equal. Here, we can’t say the sales because there must be suitable
market for the increased sales. Further, the above costs must also be controlled.
2. Reduction in cost: Capital and equity funds are utilised for production. So, all types of
steps should be taken to reduce firm’s cost of capital.
3. Sources of funds: It should be decided by keeping in view the value of the firm to
collect funds through issue of shares or debentures. Reduce risks: There won’t be profits
without risk. But for this reason, if more risk is taken, it may become danger to the
existence of the firm. Hence risk should be reduced to minimum level.
5. Long run value: It should be the feature of financial management to increase the long-run
value of the firm. To earn more profits in short time, some firms may do the activities like
releasing of low-quality goods, neglecting the interests of consumers and employees.

These trials may give good results in the short run. But for increasing the value of the firm in
the long run, avoiding; such activities are more essential.

The financial management has to take three important decision viz. (i) Investment decision i.e.,
where to invest fund and in what amount, (ii) Financing decision i.e., from where to raise funds
and in what amount, and (iii) Dividend i.e., how much to pay dividend and how much to retain
for future expansion. In order to make these decisions the management must have a clear
understanding of the objective sought to be achieved. It is generally agreed that the financial
objective of the firm should be maximization of owner’s economic welfare. There are two
widely discussed approaches or criterion of maximizing owners’ welfare - (i) Profit
maximization, and (ii) Wealth maximization. It should be noted here that objective is used in
the sense of goal or goals or decision criterion for the three decisions involved.

Profit Maximization: Maximization of profits is very often considered as the main objective
of a business enterprise. The shareholders, the owners of the business, invest their funds in the
business with the hope of getting higher dividend on their investment. Moreover, the
profitability of the business is an indicator of the sound health of the organisation, because, it
safeguards the economic interests of various social groups which are directly or indirectly
connected with the company e.g. shareholders, creditors and employees. All these parties must
get reasonable return for their contributions and it is possible only when company earns higher
profits or sufficient profits to discharge the obligations to them.

Wealth Maximization: The wealth maximization (also known as value maximization or Net
Present Worth Maximization) is also universally accepted criterion for financial decision
making. The value of an asset should be viewed in terms of benefits it can produce over the
cost of capital investment.

Wealth maximization is the ability of a company to increase the market value of its common
stock over time. The market value of the firm is based on many factors like their goodwill,
sales, services, quality of products, etc.

It is the versatile goal of the company and highly recommended criterion for evaluating the
performance of a business organization. This will help the firm to increase their share in the
market, attain leadership, maintain consumer satisfaction and many other benefits are also
there.

It has been universally accepted that the fundamental goal of the business enterprise is to
increase the wealth of its shareholders, as they are the owners of the undertaking and they buy
the shares of the company with the expectation that it will give some return after a period of
time. This states that the financial decisions of the firm should be taken in such a manner that
will increase the Net Present Worth of the company’s profit. The value is based on two factors:

a. Rate of Earning per share

 b. Capitalization Rate

The major differences between profit maximization and wealth maximization are:

The process through which the company is capable of increasing is earning capacity is known
as Profit Maximization. On the other hand, the ability of the company in increasing the value
of its stock in the market is known as wealth maximization.

Profit maximization is a short-term objective of the firm while long term objective is Wealth
Maximization. Profit Maximization ignores risk and uncertainty. Unlike Wealth Maximization,
which considers both. Profit Maximization avoids time value of money, but Wealth
Maximization recognizes it. Profit Maximization is necessary for the survival and growth of
the enterprise. Conversely, Wealth Maximization accelerates the growth rate of the enterprise
and aims at attaining maximum market share of the economy.

Comparison Chart
BASIS OF PROFIT MAXIMIZATION WEALTH MAXIMIZATION
COMPARISON

Concept The main objective of a concern is to The ultimate goal of the concern is
earn a larger amount of profit. to improve the market value of its
shares.

Emphasizes on Achieving short term objectives. Achieving long term objectives.

Consideration of Risks No Yes

and Uncertainty

Advantage Acts as a yardstick for computing the Gaining a large market share.
operational efficiency of the entity.

Recognition of Time No Yes

Pattern of Returns
 Organization Chart

Financial Decision:

i. Investment decision
ii. Financing decision
iii. Dividend decision

A. Investment Decision (Capital Budgeting Decision):

This decision relates to careful selection of assets in which funds will be invested by the firms.
A firm has many options to invest their funds but firm has to select the most appropriate
investment which will bring maximum benefit for the firm and deciding or selecting most
appropriate proposal is investment decision.

The firm invests its funds in acquiring fixed assets as well as current assets. When decision
regarding fixed assets is taken it is also called capital budgeting decision.

Factors Affecting Investment/Capital Budgeting Decisions

1. Cash Flow of the Project: Whenever a company is investing huge funds in an

investment proposal it expects some regular amount of cash flow to meet day to day
requirement. The amount of cash flows an investment proposal will be able to generate must
be assessed properly before investing in the proposal.

2. Return on Investment: The most important criteria to decide the investment proposal is
rate of return it will be able to bring back for the company in the form of income for, e.g., if
project A is bringing 10% return and project В is bringing 15% return then we should prefer
project B.
3. Risk Involved: With every investment proposal, there is some degree of risk is also
involved. The company must try to calculate the risk involved in every proposal and should
prefer the investment proposal with moderate degree of risk only.

4. Investment Criteria: Along with return, risk, cash flow there are various other criteria
which help in selecting an investment proposal such as availability of labour, technologies,
input, machinery, etc.

The finance manager must compare all the available alternatives very carefully and then only
decide where to invest the scarcest resources of the firm, i.e., finance.

Investment decisions are considered very important decisions because of following reasons:

(i) They are long term decisions and therefore are irreversible; means once taken cannot
be changed.

(ii) Involve huge amount of funds.

(iii) Affect the future earning capacity of the company.

B. Importance or Scope of Capital Budgeting Decision:

Capital budgeting decisions can turn the fortune of a company. The capital budgeting decisions
are considered very important because of the following reasons:

1. Long Term Growth: The capital budgeting decisions affect the long-term growth of the
company. As funds invested in long term assets bring return in future and future prospects and
growth of the company depends upon these decisions only.

2. Large Amount of Funds Involved: Investment in long term projects or buying of fixed
assets involves huge amount of funds and if wrong proposal is selected it may result in wastage
of huge amount of funds that is why capital budgeting decisions are taken after considering
various factors and planning.

3. Risk Involved: The fixed capital decisions involve huge funds and also big risk because
the return comes in long run and company has to bear the risk for a long period of time till the
returns start coming.

4. Irreversible Decision: Capital budgeting decisions cannot be reversed or changed

overnight. As these decisions involve huge funds and heavy cost and going back or reversing
the decision may result in heavy loss and wastage of funds. So, these decisions must be taken
after careful planning and evaluation of all the effects of that decision because adverse
consequences may be very heavy.

C. Financing Decision:
The second important decision which finance manager has to take is deciding source of finance.
A company can raise finance from various sources such as by issue of shares, debentures or by
taking loan and advances. Deciding how much to raise from which source is concern of
financing decision. Mainly sources of finance can be divided into two categories:

1. Owners fund - Share capital and retained earnings

2. Borrowed fund - Debentures, loans, bonds

The main concern of finance manager is to decide how much to raise from owners’ fund and
how much to raise from borrowed fund.

While taking this decision the finance manager compares the advantages and disadvantages of
different sources of finance. The borrowed funds have to be paid back and involve some degree
of risk whereas in owners’ fund there is no fix commitment of repayment and there is no risk
involved. But finance manager prefers a mix of both types. Under financing decision finance
manager fixes a ratio of owner fund and borrowed fund in the capital structure of the company.

Factors Affecting Financing Decisions:

While taking financing decisions the finance manager keeps in mind the following factors:

1. Cost: The cost of raising finance from various sources is different and finance managers
always prefer the source with minimum cost.

2. Risk: More risk is associated with borrowed fund as compared to owner’s fund securities.
Finance manager compares the risk with the cost involved and prefers securities with moderate
risk factor.

3. Cash Flow Position: The cash flow position of the company also helps in selecting the
securities. With smooth and steady cash flow companies can easily afford borrowed fund
securities but when companies have shortage of cash flow, then they must go for owner’s fund
securities only.

4. Control Considerations: If existing shareholders want to retain the complete control of

business then they prefer borrowed fund securities to raise further fund. On the other hand, if
they do not mind to lose the control then they may go for owner’s fund securities.

5. Floatation Cost: It refers to cost involved in issue of securities such as broker’s commission,
underwriter’s fees, expenses on prospectus, etc. Firm prefers securities which involve least
floatation cost.

6. Fixed Operating Cost: If a company is having high fixed operating cost then they must prefer
owner’s fund because due to high fixed operational cost, the company may not be able to pay
interest on debt securities which can cause serious troubles for company.

7. State of Capital Market: The conditions in capital market also help in deciding the type of
securities to be raised. During boom period it is easy to sell equity shares as people are ready
to take risk whereas during depression period there is more demand for debt securities in capital
market.

D. Dividend Decision: This decision is concerned with distribution of surplus funds. The profit
of the firm is distributed among various parties such as creditors, employees, debenture holders,
shareholders, etc. Payment of interest to creditors, debenture holders, etc. is a fixed liability of
the company, so what company or finance manager has to decide is what to do with the residual
or left-over profit of the company.

The surplus profit is either distributed to equity shareholders in the form of dividend or kept
aside in the form of retained earnings. Under dividend decision the finance manager decides
how much to be distributed in the form of dividend and how much to keep aside as retained
earnings. To take this decision finance manager keeps in mind the growth plans and investment
opportunities.

If more investment opportunities are available and company has growth plans then more is kept
aside as retained earnings and less is given in the form of dividend, but if company wants to
satisfy its shareholders and has less growth plans, then more is given in the form of dividend
and less is kept aside as retained earnings.

This decision is also called residual decision because it is concerned with distribution of
residual or left-over income. Generally new and upcoming companies keep aside more of retain
earning and distribute less dividend whereas established companies prefer to give more
dividend and keep aside less profit.

Factors Affecting Dividend Decision:

The finance manager analyses following factors before dividing the net earnings between
dividend and retained earnings:

1. Earning: Dividends are paid out of current and previous year’s earnings. If there are
more earnings then company declares high rate of dividend whereas during low earning period
the rate of dividend is also low.

2. Stability of Earnings: Companies having stable or smooth earnings prefer to give high
rate of dividend whereas companies with unstable earnings prefer to give low rate of earnings.

3. Cash Flow Position: Paying dividend means outflow of cash. Companies declare high
rate of dividend only when they have surplus cash. In situation of shortage of cash companies
declare no or very low dividend.

4. Growth Opportunities: If a company has a number of investment plans then it should

reinvest the earnings of the company. As to invest in investment projects, company has two
options: one to raise additional capital or invest its retained earnings. The retained earnings are
cheaper source as they do not involve floatation cost and any legal formalities. If companies
have no investment or growth plans then it would be better to distribute more in the form of
dividend. Generally mature companies declare more dividends whereas growing companies
keep aside more retained earnings.

5. Stability of Dividend: Some companies follow a stable dividend policy as it has better
impact on shareholder and improves the reputation of company in the share market. The stable
dividend policy satisfies the investor. Even big companies and financial institutions prefer to
invest in a company with regular and stable dividend policy. There are three types of stable
dividend policies which a company may follow:

• Constant dividend per share: In this case, the company decides a fixed rate of dividend
and declares the same rate every year, e.g., 10% dividend on investment.

• Constant pay-out ratio: Under this system the company fixes up a fixed percentage of
dividends on profit and not on investment, e.g., 10% on profit so dividend keeps on changing
with change in profit rate.

• Constant dividend per share and extra dividend: Under this scheme a fixed rate of
dividend on investment is given and if profit or earnings increase then some extra dividend in
the form of bonus or interim dividend is also given.

6. Preference of Shareholders: Another important factor affecting dividend policy is

expectation and preference of shareholders as their expectations cannot be ignored by the
company. Generally, it is observed that retired shareholders expect regular and stable amount
of dividend whereas young shareholders prefer capital gain by reinvesting the income of the
company. They are ready to sacrifice present day income of dividend for future gain which
they will get with growth and expansion of the company. Secondly poor and middle-class
investors also prefer regular and stable amount of dividend whereas wealthy and rich class
prefers capital gains. So, if a company is having large number of retired and middle-class
shareholders then it will declare more dividend and keep aside less in the form of retained
earnings whereas if company is having large number of young and wealthy shareholders then
it will prefer to keep aside more in the form of retained earnings and declare low rate of
dividend.

7. Taxation Policy: The rate of dividend also depends upon the taxation policy of
government. Under present taxation system dividend income is tax free income for
shareholders whereas company has to pay tax on dividend given to shareholders. If tax rate is
higher, then company prefers to pay less in the form of dividend whereas if tax rate is low then
company may declare higher dividend.

8. Access to Capital Market Consideration: Whenever company requires more capital it

can either arrange it by issue of shares or debentures in the stock market or by using its retained
earnings. Rising of funds from the capital market depends upon the reputation of the company.
If capital market can easily be accessed or approached and there is enough demand for
securities of the company then company can give more dividend and raise capital by
approaching capital market, but if it is difficult for company to approach and access capital
market then companies declare low rate of dividend and use reserves or retained earnings for
reinvestment.

9. Legal Restrictions: Companies’ Act has given certain provisions regarding the payment
of dividends that can be paid only out of current year profit or past year profit after providing
depreciation fund. In case company is not earning profit then it cannot declare dividend. Apart
from the Companies’ Act there are certain internal provisions of the company that is whether
the company has enough flow of cash to pay dividend. The payment of dividend should not
affect the liquidity of the company.

10. Contractual Constraints: When companies take long term loan then financier may put
some restrictions or constraints on distribution of dividend and companies have to abide by
these constraints.

11. Stock Market Reaction: The declaration of dividend has impact on stock market as
increase in dividend is taken as good news in the stock market and prices of security rise.
Whereas a decrease in dividend may have negative impact on the share price in the stock
market. So possible impact of dividend policy in the equity share price also affects dividend
decision.

Role of Financial Manager

The role of the financial manager, particularly in business, is changing in response to

technological advances that have significantly reduced the amount of time it takes to produce
financial reports. Financial managers’ main responsibility used to be monitoring a company’s
finances, but they now do more data analysis and advise senior managers on ideas to maximize
profits. They often work on teams, acting as business advisors to top executives. Financial
managers typically do the following:

1. Prepare financial statements, business activity reports, and forecasts

2. Monitor financial details to ensure that legal requirements are met

3. Supervise employees who do financial reporting and budgeting

4. Review company financial reports and seek ways to reduce costs

5. Analyse market trends to find opportunities for expansion or for acquiring other
companies

6. Help management make financial decisions

Financial managers also do tasks that are specific to their organization or industry. For
example, government financial managers must be experts on government appropriations and
budgeting processes, and healthcare financial managers must know about issues in healthcare
finance. Moreover, financial managers must be aware of special tax laws and regulations that
affect their industry.
The following are examples of types of financial managers:

1. Controllers direct the preparation of financial reports that summarize and forecast the
organization's financial position, such as income statements, balance sheets, and analyses of
future earnings or expenses. Controllers also are in charge of preparing special reports required
by governmental agencies that regulate businesses. Often, controllers oversee the accounting,
audit, and budget departments.

2. Treasurers and finance officers direct their organization's budgets to meet its financial
goals. They oversee the investment of funds. They carry out strategies to raise capital (such as
issuing stocks or bonds) to support the firm's expansion. They also develop financial plans for
mergers (two companies joining together) and acquisitions (one company buying another).

3. Credit managers oversee the firm's credit business. They set credit-rating criteria,
determine credit ceilings, and monitor the collections of past-due accounts.

4. Cash managers monitor and control the flow of cash that comes in and goes out of the
company to meet the company's business and investment needs. For example, they must project
cash flow (amounts coming in and going out) to determine whether the company will not have
enough cash and will need a loan or will have more cash than needed and so can invest some
of its money.

5. Risk managers control financial risk by using hedging and other strategies to limit or
offset the probability of a financial loss or a company’s exposure to financial uncertainty.
Among the risks they try to limit are those due to currency or commodity price changes.

6. Insurance managers decide how best to limit a company’s losses by obtaining insurance
against risks such as the need to make disability payments for an employee who gets hurt on
the job and costs imposed by a lawsuit against the company.

Financial planning is the task of determining how a business will afford to achieve its strategic
goals and objectives. Usually, a company creates a Financial Plan immediately after the vision
and objectives have been set. The Financial Plan describes each of the activities, resources,
equipment and materials that are needed to achieve these objectives, as well as the timeframes
involved.

The Financial Planning activity involves the following tasks: -

• Assess the business environment

• Confirm the business vision and objectives
• Identify the types of resources needed to achieve these objectives
• Quantify the amount of resource (labour, equipment, materials)
• Calculate the total cost of each type of resource
• Summarize the costs to create a budget
• Identify any risks and issues with the budget set
Performing Financial Planning is critical to the success of any organization. It provides the
Business Plan with rigor, by confirming that the objectives set are achievable from a financial
point of view. It also helps the CEO to set financial targets for the organization, and reward
staff for meeting objectives within the budget set.

The role of financial planning includes three categories:

1. Strategic role of financial management

2. Objectives of financial management

3. The planning cycles.

Step in Financial Planning:

1. Establishing objectives: the financial objective of any business enterprise is to employ

the capital in whatever proportion necessary to increase the productivity of the remaining
factors of production over the long run. Although the extent to which capital is employed varies
from firm to firm.

2. Policy formation: financial policies are guides to all actions which deals with procuring,
administration and disbursing the funds of business firms. Those policies may be classified into
several broad categories:

a. Policies governing the amount of capital required for firms to achieve their financial
objectives.

b. Policies which determine the control by the parties who furnish the capital.

c. Policies which act as a guide in the use of debt or equity capital.

d. Policies which guide management in the selection of sources of funds.

e. Policies which govern credit and collection activities of the enterprise.

3. Forecasting: a fundamental requisite of financial planning is the collection of facts.

However where financial plans concern the future facts are not available. Therefore the
financial management has to forecast the future variability of factors.

4. Formulation of procedure: financial policies are broad guides which to be executed

properly must be translated into detailed procedure.

Principle Governing Financial planning

1. Simplicity: the financial plan should envisage a simple financial structure capable of
being managed easily. The types of securities should be minimum, because securities of various
types give rise to unnecessary suspicion in the minds of the investing public and also create
avoidable complications.

2. Long-term view: the financial plan should be formulated and conceived by the
promoter’s management keeping in view the long-term needs of the company rather than
finding out the easiest way of obtaining the original capital would continue to operate for a
long period even after he formation of the company.

3. Foresight: the financial plan should be prepared keeping in view the future requirements
of capital for the business.

4. Optimum use: the financial plan should provide for meeting the genuine needs of the
company. The business should neither be starved of funds nor should it have unnecessary spare
funds, wasteful use of capital is as bad as inadequate capital.

5. Contingencies: the financial plan should keep in view the requirements of funds for
contingencies. It does not, however mean the capital should be kept unnecessarily idle for
meeting contingencies.

6. Flexibility: the financial plan should have a degree of flexibility also. It is helpful in
making changes or revising the plan according to pressure of circumstances with minimum
possible delay.

7. Liquidity: the ability of the enterprise to make available the ready cash whenever
required to make disbursement. Adequate liquidity in the financial plan gives it a degree of
flexibility too.

Financial Analyst

Financial analysts are responsible for a variety of research tasks to inform investment strategy
and make investment decisions for their company or clients. These roles are data-intensive and
require strong mathematical and analytical skills.

A financial analyst is responsible for a variety of research tasks in order to inform investment
strategy and make investment decisions for their company or clients. This can include things
like evaluating financial data, examining current events and market developments, examining
an organization’s financial statements, and creating financial models to predict future
performance. Depending on the position, analysts can monitor macroeconomic trends or have
a narrow focus on specific sectors and industries. These roles are data-intensive and require
strong mathematical and analytical skills. Given the value of their role, financial analysts can
be employed by large corporations such as investment banks, insurance companies, mutual
funds, hedge funds, pension funds, securities firms, investment firms, private equity groups,
venture capital firms, government agencies, and similar types of organizations.
 Unit 2: Time value of money:
The concept of time value of money suggests that the money received at different point of time
has different value. The financial manager must appreciate this fact and understand why they
are different and how they are made comparable.

Time value of money is a concept to understand the value of cash flows occurred at different
point of time. If we are given the alternatives whether to accept Rs. 100 today or one year, then
we certainly accept Rs. 100 today. It is because there is a time value to money. Every sum of
money received earlier has reinvestment opportunity.

For example, if we deposited Rs. 100 in saving account at 5% annual rate of interest, it will
increase to Rs. 105 at the end of one year. Money received at present is preferred even if we
do not have reinvestment opportunity. The reason is that the money that we receive in future
has less purchasing power than the money that we have at present due to the inflation. What
happens if there is no inflation? Still, money received at present is preferred; it is because most
of us have a fundamental behaviour to prefer current consumption to future consumption. Thus,

a) The reinvestment opportunity or the earning power of the money,

b) The risk of inflation, and

c) An individual's preference for current consumption to future consumption are the

reasons for the time value of money.

The concept of time value of money is useful in addressing our real-life problems relating to
planning for future family expenditure. For instance, if we need Rs. 50,000 after the retirement
from job in 15 years, the amount we need to deposit at interest every year from now until the
retirement is conveniently determined by using the time value of money concept.

Many financial decisions of the firm require a consideration regarding time value of money.
The corporate manager must always concentrate on maximizing shareholders wealth.
Maximizing shareholders wealth, to a larger extent, depends on the timing of cash flows from
investment alternatives. In this regard, time value of money concept deserves serious
considerations on all financial decisions. Significance of The Concept of Time Value of Money

Time value of money is a widely used concept in literature of finance. Financial decision
models based on finance theories basically deal with maximization of economic welfare of
shareholders. The concept of time value of money contributes to this aspect to a greater extent.

Reason for time preference of money:

1. Money has a time value because it is associated with the opportunities available.

2. Meeting current requirement than future.

3. Time value of money is used for calculating uncertainties in terms of monetary value.
4. Economic situation will always fluctuate in inflationary or deflationary impacts.

Present Value:

Present value (PV) is the current worth of a future sum of money or stream of cash flows given
a specified rate of return. Future cash flows are discounted at the discount rate, and the higher
the discount rate, the lower the present value of the future cash flows. Determining the
appropriate discount rate is the key to properly valuing future cash flows, whether they be
earnings or obligations.

1. Present value of Single cash flow

a. PV = A / [1 + i] n

2. Present value of Multiple cash flow

Cash inflow * Present value factor

3. Present value of annuity

a. At the end of each period

PV = a/i [1 – 1 / (1+i) n]

b. At the beginning of each period

PV = a/i (1 + i) [1 – 1 / (1 + i) n]

Future Value:

Future value is the value of an asset at a specific date. It measures the nominal future sum of
money that a given sum of money is "worth" at a specified time in the future assuming a certain
interest rate, or more generally, rate of return; it is the present value multiplied by the
accumulation function. The value does not include corrections for inflation or other factors that
affect the true value of money in the future. This is used in time value of money calculations.

1. Future value of single cash flow

FV = P [1+i] n

2. Future value of multiple flows or a series of flows

a. At the end of each period

FV = P1[1+i] n-1 + P2 [1+i] n-2 + ------- +Pn

b. At the beginning of each period

FV = P1[1+i] n + P2[1+i] n-1+ ------ Pn[1+i]

3. Future value of annuity

a. At the end of each period

FV = a/i [(1+i) n - 1]

b. At the beginning of each period

FV = a/i (1 + i) [(1 + i) n – 1]

Doubling Period:

It is the method in which a particular sum of money is doubled in a definite period of time at a
specified rate of interest. In how many years a sum of deposit is doubled at given rate of interest.

There are two rules for calculating doubling period:

Rule of 72 = 72 / Rate of interest

Rule of 69 = 0.35 + (69/Rate of interest)