Introduction to

Financial
Management
 What is Finance
• Finance can be defined as the science and art of managing
money. Every enterprise, whether big, medium, small, needs
finance to carry on its operations and to achieve its target. In
fact, finance is so indispensable today that it is rightly said to
be the blood of an enterprise. Without adequate finance, no
enterprise can possibly accomplish its objectives.
• Business finance can be broadly defined as the activity
concerned with the planning, raising controlling and
administrating the funds used in the business.
 What is Finance……(Con…t)
• Finance is the study of how people and businesses evaluate
investments and raise capital to fund them. (-- How to get and
use money)
• Three questions addressed by the study of finance
1. What long-term investments should the firm undertake? (capital
budgeting decisions – how to spend the money?)
2. How should the firm fund these investments? (capital structure
decisions -- How to get the money?)
3. How can the firm best manage its cash flows as they arise in its day-to-day
operations? (working capital management decisions – how to
manage cash (liquid) money?)
 What is Financial Management?
• The term financial management has been defined by Solomon, “It is concerned
with the efficient use of an important economic resource namely, capital funds”.
• The most popular and acceptable definition of financial management as given by
S.C. Kuchal is that “Financial Management deals with procurement of funds and
their effective utilization in the business”.
• Howard and Upton : Financial management “as an application of general
managerial principles to the area of financial decision-making.
• Weston and Brigham : Financial management “is an area of financial decision-
making, harmonizing individual motives and enterprise goals”. Joshep and
Massie : Financial management “is the operational activity of a business that is
responsible for obtaining and effectively utilizing the funds necessary for efficient
operations.
• Thus, Financial Management is mainly concerned with the effective funds
management in the business. In simple words, Financial Management as
practiced by business firms can be called as Corporation Finance or Business
Finance.
 Importance of Financial
Management
• Financial Planning
• Acquisition of Funds
• Proper use of Funds
• Financial Decision
• Improve Profitability
• Increase the value of Firm
• Promoting Savings
 Functions of Finance Manager
• Forecasting Financial Requirements
• Acquiring Necessary Capital
• Investment Decision
• Cash Management
• Interrelation with Other Departments
 Traditional View Vs. Modern View
of Finance
Traditional Approach to Finance Function : The traditional approach to the scope
of finance refers to its subject matter in the academic literature in the initial
stages of its evolution as a separate branch of study.
According to this approach, the scope of finance is confined to the raising of funds.
Hence, the scope of finance was treated by the traditional approach in the narrow
sense of procurement of funds by corporate enterprise to meet their financial
needs.
Since the main emphasis of finance function at that period was on the procurement of
funds, the subject was called corporation finance till the mid-1950's and covered
discussion on the financial instruments, institutions and practices through which
funds are obtained.
These are the broad features of the subject matter of corporation finance, which has
no concern with the decisions of allocating firm's funds.
 Traditional View Vs. Modern View of Finance
…………(Con….t)

The traditional approach to the scope and functions of finance has now
been discarded as it suffers from many serious limitations:
(i) It is outsider-looking in approach that completely ignores internal decision
making as to the proper utilization of funds.
(ii) The focus of traditional approach was on procurement of long-term funds.
Thus, it ignored the important issue of working capital finance and management.
(iii) The issue of allocation of funds, which is so important today, is completely
ignored.
(iv) It does not lay focus on day to day financial problems of an organization.
 Traditional View Vs. Modern View of Finance
…………(Con….t)

Modern Approach to Finance Function: According to this approach,

financial management considers the broader and analytical
viewpoint. According to this approach, financial management is
concerned with both acquisition of funds and their effective and
optimum utilization. This viewpoint not only considers the sporadic
events but also the long term and short-term financial problems.
Three decisions are taken under financial management :-
i. Investment Decision
ii. Financing Decision
iii. Dividend Decision
 Traditional View Vs. Modern View of Finance
…………(Con….t)

Traditional Approach Modern Approach

Narrowly defined concept of FM Comparatively a wide concept
Only concerned with raising long term Concerns both raising as well as use of
funds funds
Era before 1950 Era after 1950
Applicable only to large joint stock
companies Applicable to all the business entities
Long as well as short term decisions
Only long-term decisions were taken are taken
Both, inside as well as outside
 Goal of Finance
• Goal of finance or a finance manager is to optimize the
corporate objectives, vision and mission of a business
organization. Way of doing the above said things are two :
1. Profit Maximization
2. Wealth Maximization
 Goal of Finance………(Con….t)
Favorable Arguments for Profit Unfavorable Arguments for
Maximization Profit Maximization
(i) Main aim is earning profit.
(i) Profit maximization leads to
(ii) Profit is the parameter of the exploiting workers and consumers.
business operation.
(iii) Profit reduces risk of the (ii) Profit maximization creates
business concern. immoral practices such as corrupt
(iv) Profit is the main source of practice, unfair trade practice, etc.
finance. (iii) Profit maximization objectives
(v) Profitability meets the social leads to inequalities among the
needs also. sake holders such as customers,
suppliers, public shareholders, etc.
 Goal of Finance………(Con….t)
Criticism of Profit Maximization:
(i) Ambiguity
(ii) Time Value of Money
(iii) Risk Factor
 Goal of Finance………(Con….t)
• Wealth Maximization: Financial theory asserts that the
wealth maximization is the single substitute for a stake
holder’s utility. When the firm maximizes the
shareholder’s wealth, the individual stakeholders can use
this wealth to maximize his individual utility. It means that
by maximizing stakeholder’s wealth the firm is operating
consistently toward maximizing
Maximum
Maximum current stock
stakeholder’s
Maximum utility. stockholder’s
Utility price per share
wealth
 Goal of Finance………(Con….t)
Favorable Arguments for Wealth Unfavorable Arguments for Wealth
Maximization Maximization
(i) Wealth maximization is superior to the profit (i) Wealth maximization leads to prescriptive idea
maximization because the main aim of the of the business concern but it may not be suitable
business concern under this concept is to to present day business activities.
improve the value or wealth of the shareholders. (ii) Wealth maximization is nothing, it is also profit
(ii) Wealth maximization considers the maximization, it is the indirect name of the profit
comparison of the value to cost associated with maximization.
the business concern. Total value detected from (iii) Wealth maximization creates ownership-
the total cost incurred for the business management controversy. (iv) Management alone
operation. It provides extract value of the enjoy certain benefits.
business concern. (v) The ultimate aim of the wealth maximization
(iii) Wealth maximization considers both time and objectives is to maximize the profit.
risk of the business concern. (vi) Wealth maximization can be activated only
(iv) Wealth maximization provides efficient with the help of the profitable position of the
 Agency Problem & Finance
• Agency problem is the likelihood that managers may place
personal goals ahead of corporate goals.
• Reason of agency problem:
1. Agent is risk-averter & principal is risk-seeker.
2. Agent has shorter duration than the principal in
the organization
3. Earnings of agent are fixed
4. Principals are not directly take part in
management decision
5. Information asymmetry
 Agency Problem & Finance……
(Con….t)
• Resolving agency problem:

Agency Cost
1. Monitoring
Market Forces
Expenditures
1. Behavior of security
2. Bonding Expenditures
market participants
3. Structuring
2. Hostile Takeover
Expenditures( incentive
and performance plan)
 Finance & Related Disciplines
• Finance and Economics
• Finance and Accounting