Financial Management
Financial Management
Finance + Management = Financial Management
Finance: Funds/money/wealth for daily transactions
of the business.
Management: The process of planning, organizing,
directing and controlling the business activities.
Financial management means planning, organizing,
directing and controlling the financial activities
such as procurement and utilization of funds of the
enterprise.
Financial management means applying general
management principles to financial resources
of the enterprise.
Finance is the life blood of every business
transaction and it termed as the backbone of
every business organization.
Nature of Financial Management
• Estimates capital requirements
• Decides capital structure
• Select sources of funds
• Select investment pattern
• Raises shareholders value
• Management of cash
• Apply financial controls
1. Estimates Capital Requirements-
Anticipation of funds required for running the business.
Estimates working and fixed capital requirements for carrying out all
business activities.
Finance manager prepares a budget of all expenses & revenues for a
particular time period.
On the basis of which capital requirements decided.
2. Decides capital structure-
Deciding optimum capital structure for an organization is a must for
attaining efficiency and earning better profits.
It involves deciding the proper portion of different securities like
common equity, preferred equity, and debt.
The proper balance between debt and equity should be attained which
minimizes the cost of capital.
3. Select sources of Fund-
Choosing the source of funds is one of the crucial decisions for
every organization.
There are various sources available for raising funds like shares,
bonds, debentures, venture capital, financial institutions,
retained earnings, owner investment, etc.
Every business should properly analyze different sources of
funds available and choose one which is cheapest and minimal
risk
4. Selects investment pattern-
Once funds are procured it is important to allocate them among
profitable investment options.
The investment proposal should be properly analyzed regarding
its safety, profitability, and liquidity.
Before investing any amount in it all risk and return associated
with it should be properly evaluated.
5. Raises Shareholders value–
Financial management works towards raising the overall value of
shareholders.
It aims at increasing the amount of return to shareholders by
reducing the cost of operations and increasing the profits.
The finance manager focuses on raising cheap funds from different
sources and invest in the most profitable options.
6. Management of cash-
Financial management monitors all funds movement in an
organization.
Finance managers supervise all cash movements through proper
accounting of all cash inflows and outflows.
They ensure that there is no situation like deficiency or surplus of
cash in an organization.
7. Apply financial controls-
Implying financial controls in business is a beneficial role
played by financial management.
It helps in keeping the company actual cost of operation
within the limit and earning the expected profits.
There are various processes involved in this like developing
certain standards for business in advance, comparing the
actual cost or performance with pre-established standards,
and taking all required remedial measures.
Financial Goals
Profit
maximization
Financial
Goals
Wealth
maximization
Profit vs. Wealth
• Profit = Income – Expenses
{+ve profit}
{-ve loss}
• Wealth = no. of shares held x Market price
per share
Profit maximization
• In traditional approach business is considered
to be an economic organization and profit is
considered to be a good standard to measure
its efficiency.
• Acc. to this approach, Co. should earn profit out
of its available resources and dividend policies
should be based on maximization of profits.
This approach
suggests…..
acceptance of
profitable projects only
all resources used for
earn more profits
Advantages of Profit Maximization
1. Rationale
(justified on ground of rationality, profits/losses)
2. Indicator of economic efficiency
(comparing among existing Co. with profits)
3. Traditional objective of business
4. Measurement of success of business decisions
5. Source of incentive (more
profits, more incentives, more bonuses)
6. Easy to calculate
Disadvantages of Profit Maximization
1. Vague Concept
(Gross/ Net)
2. Ignores time value of money
(inflated economy, money value, doesn’t consider return benefits)
3. Overlooks quality aspect
4. Ignore social responsibility of business
(only focused on profit of business)
5. Narrow concept (in
comparison to wealth max.)
6. Ignore risk factor
Wealth Maximization
• It is considered a main objective rather than
profit maximization.
• The price of the shares reflect the value of
assets of the company.
• The wealth of the shareholders increase only
when there is increase in price of shares.
• The term wealth means Sh. holder’s wealth.
• This is also known as value maximization or
net present value (NPV) maximization.
• Where, NPV is the difference between the
present value of benefits realized and the
present value of costs incurred by a business.
• Co. which issue eq. shares and the price of
those shares are quoted in stock market, then
the market price of shares is an indicator
whether the value of assets of the firm are
increasing or not.
• The price of share of Co. is affected by the
earned quantity of profit but this is also
possible the shares of the profit earning Co. are
not an increasing because the market value of
share is affected not only by the quantity of
profits of the Co. but also profit earning
capacity, dividend policy of companies,
liquidity, and assets etc.
• Therefore, even when the quantity of profit is
same in two different companies their market
value of shares are different.
• The market value of share is indicator of
prosperity and efficiency of the enterprise.
Advantages of Wealth Maximization
• Clear indicator
(of wealth of business)
• Based on time value of money
• Universal acceptance
• Consider risk factor
• Provides directions to the management
( for clear dividend policies)
Difference between Profit Maximization
and Wealth Maximization
1. Old concept and 1. New concept
natural objective of
any business 2. Difficult to calculate
2. Easy to calculate 3. Clear concept
3. Vague concept 4. Consider time value of
4. Ignore time value of money
money 5. Consider risk and
5. Ignore risk and uncertainty
uncertainty
