Financial Management Notes (Original)
1. Introduction to Financial Management
Definition: Financial management is the process of planning, organizing, directing,
and controlling financial resources of a business to maximize shareholder wealth.
Objectives:
o Profit maximization (short-term).
o Wealth maximization (long-term, superior).
o Ensuring liquidity and stability.
o Optimal utilization of funds.
2. Functions of Financial Management
1. Investment Decisions (Capital Budgeting) – Where to invest funds.
2. Financing Decisions – How to raise funds (equity, debt, retained earnings).
3. Dividend Decisions – How much profit to distribute vs. retain.
4. Liquidity Decisions – Managing working capital (cash, receivables, inventory).
3. Time Value of Money (TVM)
Concept: A rupee today is worth more than a rupee tomorrow.
Key Techniques:
o Present Value (PV) = FV ÷ (1 + r)^n
o Future Value (FV) = PV × (1 + r)^n
o Annuities: Equal payments over time.
o Perpetuities: Infinite annuity.
4. Sources of Finance
1. Long-term: Equity shares, Preference shares, Debentures, Term loans.
2. Medium-term: Lease, Hire purchase, Venture capital.
3. Short-term: Trade credit, Bank overdraft, Commercial paper.
4. Internal: Retained earnings, Reserves.
5. Capital Structure
Definition: Mix of debt and equity in financing.
Theories:
o Net Income Approach.
o Net Operating Income Approach.
o Modigliani & Miller (M-M) Theory.
o Traditional Approach.
Optimum Capital Structure: Minimizes cost of capital, maximizes firm value.
6. Cost of Capital
Definition: Minimum return expected by investors.
Types:
o Cost of Debt = Interest × (1 – Tax rate) ÷ Net proceeds.
o Cost of Equity = Dividend per share ÷ Market price + Growth.
o Cost of Preference = Dividend ÷ Net proceeds.
Weighted Average Cost of Capital (WACC) = Weighted average of costs of all
sources.
7. Capital Budgeting
Definition: Long-term investment decision-making.
Techniques:
1. Payback Period.
2. Accounting Rate of Return (ARR).
3. Net Present Value (NPV).
4. Internal Rate of Return (IRR).
5. Profitability Index.
Rule: Accept projects with positive NPV or IRR > Cost of Capital.
8. Working Capital Management
Definition: Managing current assets & current liabilities.
Types:
o Permanent working capital.
o Temporary working capital.
Determinants: Nature of business, operating cycle, credit policy.
Techniques: Inventory management, cash management, receivables management.
9. Dividend Policy
Definition: Policy regarding distribution of earnings to shareholders.
Theories:
o Walter’s Model.
o Gordon’s Model.
o Modigliani & Miller (M-M) Theory (dividend irrelevant).
Factors Affecting: Earnings, Liquidity, Growth prospects, Legal restrictions.
10. Risk & Return
Risk: Uncertainty of returns.
Return: Actual gain/loss from investment.
Types of Risk:
o Systematic (market risk).
o Unsystematic (business, financial risk).
CAPM (Capital Asset Pricing Model):
o Expected Return = Risk-free rate + Beta × (Market Return – Risk-free rate).
11. Leverage
Operating Leverage: Effect of fixed operating costs on EBIT.
Financial Leverage: Effect of debt on EPS.
Combined Leverage = Operating × Financial leverage.
High leverage = high risk, high return.
12. Modern Trends in Financial Management
Behavioral Finance – Psychology in decision-making.
Fintech & Digital Finance – Online payments, blockchain, AI in finance.
ESG Finance – Environmental, Social, and Governance investing.
Globalization of Finance – Cross-border capital flows.
